Bloated inventories are changing cash flow strategies

Increased inventory levels are having multiple impacts on businesses, from higher carrying costs to lower profitability.

An April CNBC Supply Chain Survey found that 36% of businesses expected inventories to return to normal in the second half of the year, but just as many saying the glut will last into 2024.

Because companies must pay taxes on inventory held, the excess items on hand are having a detrimental effect on the bottom line.

“The companies that are holding larger inventory amounts for a larger period of time, that is putting added stress on their balance sheets,” Maureen Sullivan, who leads supply chain finance for MUFG Americas, part of global banking and investment firm MUFG Bank.

The Wall Street Journal in February reported that more companies were switching their accounting strategies from a “last-in, first-out” (LIFO) standard to “first-in, first-out” (FIFO). The difference is in how companies account for the cost of goods sold. According to the NYS Society of CPAs, FIFO “can boost a company’s profitability because older inventory acquired at a lower cost is used to value the cost of goods sold on the income statement.”

Sullivan said MUFG is seeing more interest in supply chain finance programs. Typically, these programs, part of the firm’s Working Capital Solutions group, improve the cash conversion cycle of a business through the discounting of their receivables or increasing their days payable outstanding. According to the company’s website, “supply chain finance helps buyers strengthen relationships with their suppliers by providing them with access to economically priced short-term funding.”

Sullivan said that supply chain finance can often be obtained at lower rates than a traditional bank loan.

“If they were to try and borrow with their local bank for that receivable, most banks would advance maybe 80% of that receivable at a much higher rate,” she says. “They can liquidate that receivable and redeploy those funds at an attractive rate.”

Companies interested in supply chain finance should look at whether the rates they receive, in addition to the discount they may have to pay, justifies the program. Sullivan also advised them to negotiate with counterparties to extend payment terms. Some suppliers, though, “may be reluctant to accept longer payment terms because they may have their own liquidity concerns.”

“We are seeing growth in our supply chain finance programs that we manage for our clients for a couple of reasons,” Sullivan says. “Some of our buyers are negotiating their terms to match their inventory terms so it doesn’t have a detrimental impact on their [balance sheet]. Seller can sell almost immediately on the platform to get their cash. It’s [also] a way to ensure their buyers are stable while having enough liquidity and allowing the buyers to manage their own [costs].”

FASB accounting changes

In late 2022, the Financial Accounting Standard Board made a long-awaited change to accounting rules for companies using supply chain finance programs. While the change was not significant in terms of effort, it is significant in terms of visibility, Sullivan points out.

Companies that use supply chain finance programs were previously allowed to note their use in a footnote on financial statements, if they noted them at all. There was concern in the investment community, though, that use of these programs was shielding the true financial health of the company. Sullivan says investors were concerned, and FASB agreed.

Finance programs are now required to be listed in the balance sheet as a disclosure that includes the description of terms, including if there is any collateral involved. In December, a requirement to disclose any “roll forward payment balance” will be added to the rules. That requirement will require quarter-over-quarter reporting – did the finance program grow or shrink?

“I think it’s really around clarity and transparency,” Sullivan says. “There had been a request for understanding if a supply chain financing program is in place, if its size and impact could it impact a company’s working capital.”

Company auditors should be versed in the FASB disclosure requirement and looking to ensure it is included on financial statements.

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