Supplier Finance and Factoring: Hidden Leverage

Introduction

Coca-Cola pays most of its suppliers on 120-day terms. Suppliers who do not want to wait that long can sell their invoices to banks through a supply chain finance program that prices the advance on Coca-Cola's credit, not their own. At the end of 2024, $1.3 billion of Coca-Cola's payables had been confirmed under the program. On the other side of its working capital, Coca-Cola sold $21.9 billion of its own receivables to banks during the year through a factoring program, at a cost of $114 million, collecting cash well before its customers paid.

Neither arrangement appears as debt on the balance sheet, and both improve operating cash flow and working capital ratios. That is why bankers look at them closely. Supplier finance, often called reverse factoring, lets a buyer stretch its payment terms while banks fund its suppliers; factoring lets a seller collect early by selling receivables. Used moderately, both are ordinary treasury tools. Used heavily, they can disguise borrowing, as the collapse of Carillion showed, a case discussed in why profitable companies run out of cash, and if the banks pull back, the cash they provided has to be replaced quickly.

In a supplier finance program, a buyer arranges for one or more banks to offer its suppliers early payment of approved invoices. The supplier receives cash shortly after the invoice is confirmed, less a discount based on the buyer's credit rating; the bank collects the full amount from the buyer on the original due date, or sometimes later. The supplier gets cheap, fast cash; the buyer can negotiate longer payment terms; the bank earns a margin.

Supplier finance program

An arrangement in which a buyer agrees with a finance provider that its suppliers may be paid early on confirmed invoices, while the buyer pays the finance provider on the original or a later due date. It is also called reverse factoring or supply chain finance.

For the buyer, the accounting question is whether the payable is still a trade payable. If the program does not change the amount, timing or nature of the obligation, the liability usually stays in accounts payable, payments to the bank are shown in operating cash flow, and the program's main effect is to support longer payment terms. If the terms are substantially changed, for example if the buyer pays the bank much later than normal terms with suppliers, or gives the bank security, the liability can become a borrowing, presented as debt. The cash flow statement then shows the bank's payment to the supplier as an operating outflow matched by a financing inflow, as if the buyer had borrowed and paid the supplier itself, and the buyer's later repayment to the bank as a financing outflow.

The difference matters for cash flow. Suppose a company buys $1,200 a year of supplies and pays on 60-day terms, carrying about $200 of payables. Moving to 120-day terms, supported by a supplier finance program, doubles payables to about $400. In the year of the change, operating cash flow rises by about $200, a one-time gain that does not recur; in later years, operating cash flow is unchanged. That calculation is the payables side of the working capital ratios, days sales outstanding (DSO), days inventory outstanding (DIO) and days payable outstanding (DPO), explained in how DSO, DIO and DPO drive working capital.

Before 2023, investors often could not tell how much of a company's payables sat in such programs. Accounting Standards Update (ASU) 2022-04 changed that. Deloitte's summary of the supplier finance disclosure update explains that buyers must now disclose the key terms of their programs, the confirmed amount outstanding at period end, where it is presented in the balance sheet and, from fiscal years beginning after December 15, 2023, a roll-forward of the obligations. The standard changes disclosure only, not recognition or presentation.

Coca-Cola's 2024 annual report provides the roll-forward:

Coca-Cola states that its payment terms are the same whether or not a supplier participates, that it provides no guarantees and that it has no economic interest in a supplier's decision, which supports keeping the obligations in payables and the cash flows in operating activities. The roll-forward shows a stable program: invoices confirmed and paid roughly offset, so the program neither boosted nor drained operating cash flow materially during the year.

Factoring works on the other side of the balance sheet. A company sells receivables to a bank or finance company for cash, at a discount, before customers pay. If the transfer meets the conditions of Accounting Standards Codification (ASC) 860, chiefly that the receivables are legally isolated from the seller and its creditors, the buyer is free to pledge or sell them, and the seller keeps no effective control over them, the receivables are removed from the balance sheet, the cash received is generally shown in operating activities, and the discount is recorded as a cost. The test is about control, not risk: a sale with recourse, where the seller compensates the factor for customer defaults, can still qualify, with the recourse obligation recorded as a liability. If the conditions fail, for example because recourse is so extensive that the receivables are not legally isolated, or the seller can take them back, the arrangement is a secured borrowing: the receivables stay on the balance sheet and the cash is a financing inflow.

Factoring

The sale of accounts receivable to a bank or finance company at a discount in exchange for immediate cash. When the sale qualifies for derecognition, the receivables leave the seller's balance sheet and the cash is usually reported in operating activities.

The size of the discount depends on the credit quality of the customers whose invoices are sold and on how long they take to pay, so factoring is cheapest for companies with strong customers and short terms. The seller often keeps collecting from customers and passing the cash on to the factor, as Coca-Cola does for ease of administration, so customers may never notice the sale. Where the discount lands also matters: Coca-Cola reports its factoring costs in other income (loss), net, below operating income, so the cost of collecting early never touches operating margin.

Coca-Cola's factoring program, through which it sold $21.9 billion of receivables in 2024, up from $17.7 billion in 2023, is a large example. Because the cash received is classified in operating activities, an expanding factoring program lifts operating cash flow in the years it grows, and an analyst comparing operating cash flow across years or across companies needs to know whether, and by how much, factoring changed.

Both arrangements replace something that would otherwise require borrowing. A company that stretches its suppliers to 120 days through a bank-funded program is, economically, using the bank's balance sheet to fund its inventory; a company that factors its receivables is borrowing against them. Yet in most cases neither shows up as debt, and both improve the metrics lenders and investors watch most closely: operating cash flow, free cash flow, working capital and leverage ratios.

The risk is reversal. Programs depend on banks' willingness to fund them, which depends on the buyer's credit. If the buyer's rating falls, banks can withdraw, suppliers revert to normal terms or demand faster payment, and the buyer must suddenly fund the payables itself, absorbing cash just when it is weakest. Factoring programs can be curtailed in the same way. Carillion's early payment facility is the best-known example of a program that made a struggling company look liquid until it could not.

Bankers therefore read the disclosures alongside the working capital trends. Rising DPO alongside a growing supplier finance balance, or falling DSO alongside a growing factoring program, means working capital has been financed rather than improved. The debt figures they are compared with, and how debt-like items are presented, are covered in debt on the balance sheet, and the ratios that combine them in leverage and coverage ratios. The question in every case is the same: is the company collecting faster and paying later because its business has improved, or because a bank is standing in between?