The Nasty Shock When Cash Supplies Are Switched Off

When the global economy went into hibernation to try to halt the spread of Covid-19, companies everywhere scrambled to get their hands on cash. Banks, shareholders, and governments were all tapped for money, but self-help played a big part too. Businesses tried to clear their inventories, to get paid quickly for their products and services, and to pay their bills more slowly. A company that does all those things should have more funds in the bank to pay wages and other fixed costs—crucial if you want to survive an economic crisis of this scale.

As is so often the case, those creative types in the finance industry have come up with a smorgasbord of ways to help firms increase their cash holdings. The oldest and most common is called factoring. Essentially, if you’re a cash-strapped company whose customers are dragging their feet on paying their bills, no problem: A bank will give you an advance on those invoices, for a fee. Another increasingly fashionable technique is a more complicated service known as reverse factoring or supply-chain finance. This allows a company’s suppliers to quickly get paid what they’re owed. The company then refunds the finance provider at a later date.

Both of these techniques—known as “invoice financing”—generate chunky fees for banks and fintechs such as Greensill Capital, a reverse-factoring specialist backed by SoftBank’s Vision Fund. Viewed positively, these arrangements help keep the wheels of commerce oiled, especially at a time when supply chains face massive disruption—and uncertain payment schedules—because of the pandemic. In theory, they let everyone get their money reasonably quickly. However, this is really just another kind of short-term borrowing, and one that’s not well-understood by investors. It can lead to nasty surprises.

Most obviously, there’s the risk of fraud, where individuals raise financing against fake invoices. That may have contributed to the collapse of London-listed hospital operator NMC Health Plc, according to the Financial Times.

But the economic upheaval caused by the coronavirus has exposed other potential problems. If a company suddenly stops using invoice financing—either voluntarily or because its banks tighten credit terms—that can worsen its cash-flow difficulties at exactly the wrong moment. This happened when British contractor Carillion Plc collapsed two years ago. Furthermore, these arrangements aren’t always disclosed in a transparent way, making it difficult to get a full picture of a company’s accounts. Consider these four examples:

• ThyssenKrupp AG. Having completed the 17 billion euro (US$20 billion) sale of its elevators division, German steelmaker ThyssenKrupp’s financial position is now much improved. Yet its shares tumbled 16 percent last week when it disclosed that 2.5 billion euros of those proceeds will be gobbled up by the normalization of its working-capital arrangements. The company had used invoice financing for about 2 billion euros of its receivables every year, and most of this will be halted. ThyssenKrupp will also stop delaying payments to some suppliers at the end of each financial year, which prettified its accounts and helped it comply with banking covenants. Typically, this was then followed by a large cash outflow in the first quarter of the new financial year when supplier payments came due. ThyssenKrupp always disclosed its factoring facility in the footnotes to its financial statements, but some investors might not have been paying attention.
• Rolls-Royce Holdings Plc. In February, Rolls-Royce surprised investors by quantifying the full extent of its invoice-financing arrangements for the first time. The British aircraft-engine maker’s annual report revealed it had drawn 1.1 billion pounds under a factoring facility, which allowed it to collect cash it was owed more quickly. Furthermore, its suppliers have drawn 860 million pounds using a supply-chain finance facility. Both arrangements helped improve Rolls-Royce’s perennially weak cash flow. When it announced first-half results in July, the group announced that it has stopped factoring its receivables. It said the decision was voluntary and would lower its financing costs. But free cash flow was 1.1 billion pounds lower than investors expected.
• Bombardier Inc. The Canadian train and private-jet manufacturer became a prolific user of invoice financing after overextending itself trying to launch several new aircraft programs. It’s in the process of breaking itself up but hasn’t completed the sale of its train division to France’s Alstom SA. Until those proceeds arrive, Bombardier needs to keep hold of its cash. It’s unfortunate, then, that Bombardier will suffer a roughly $320 million negative cash impact in the second half of the year because of winding down a reverse-factoring facility used by its aviation business. “Disruptions to the financial markets have rendered this facility too expensive,” management explained on an investor call.
• Leoni AG. Factoring is possible only if you have a sufficient quantity of invoices to sell to the bank. Leoni, a struggling German automotive supplier, depended on selling its receivables to generate cash. This became a problem in March when carmaker customers suddenly halted production and curtailed their orders. With fewer invoices to sell, Leoni was forced to go, cap in hand, to the government for a 330 million euro state-backed loan.

Taken together, these four cases show the pitfalls of this technique. If invoice financing can cease just when it is needed most, that’s all the more reason for investors to treat it as quasi-debt. And it’s imperative that disclosures, particularly around reverse factoring, be improved. Ultimately, investors need to understand exactly how a company is generating cash.

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