Situation already so bad that hiding debt becomes a priority?
Australian engineering group UGL, which is working on large infrastructure projects such as Brisbane’s Cross River Rail and Melbourne’s Metro Trains, recently sent a letter to suppliers and sub-contractors informing them that as of October 15, they will be paid 65 days after the end of the month in which their invoices are issued. The company’s policy had been, until then, to settle invoices within 30 days.
The letter also mentioned that if the suppliers want to get paid sooner than the new 65-day period, they can get their money from UGL’s new finance partner, Greensill Capital, one of the biggest players in the fast growing supply chain financing industry, in an arrangement known as “reverse factoring”. But it will cost them.
Reverse factoring is a controversial financing technique that played a major role in the collapse of UK construction giant Carillion, enabling it to conceal from investors, auditors and regulators the true magnitude of its debt.
Here’s how it works: a company hires a financial intermediary, such as a bank or a specialist firm such as Greensill, to pay a supplier promptly (e.g. 15 days after invoicing), in return for a discount on their invoices. The company repays the intermediary at a later date. This effectively turns the company’s accounts payable into debt that is owned a financial institution. But this debt is not disclosed as debt and remains hidden.
In its letter to suppliers, UGL trumpeted that the payment changes would “benefit both our businesses,” though many suppliers struggled to see how. One subcontractor interviewed by The Australian Financial Review complained that the changes were “outrageous” and put small suppliers at a huge disadvantage since they did not have the power to challenge UGL. Some subcontractors contacted by AFR refused to be quoted out of fear of reprisal from UGL.
Reverse factoring is that it can be used by companies to create the illusion of cash flow, reduce the appearance of debt, and mask the true state of their leverage ratios. UGL’s massive parent company, CIMIC, has been accused of doing just that by Hong Kong research group GMT. Since the allegation went public, in May, CIMIC’s shares have lost 38% of their value.
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