When analysing receivables and payables the focus of investors tends to be on their cash flow and liquidity effects. However, these balances also impact financial leverage and equity risk, which may affect the comparability of valuation metrics. Factoring and other working capital financing contributes to the problem, but all companies are potentially affected.
We explain the leverage effects of receivables and payables, and use two European Auto Parts companies to demonstrate how equity valuation metrics can be adjusted to provide additional analytical insights. We also consider how the accounting for working capital balances and financing arrangements complicates the analysis.
Trade receivables and trade payables are usually regarded as operating assets and liabilities, and components of net working capital, for the purpose of equity analysis. The same applies to the related contract assets and liabilities that arise from applying accruals accounting in revenue recognition. Classification as operating means these items are not included in financial leverage metrics, nor as a financing claim or non-operating asset in enterprise value calculations. For invested capital they appear on the net operating asset side of the balance sheet alongside other operating assets, including fixed assets and inventory.
A reduction in net working capital is generally viewed favourably by investors – but should it?
The focus for the analysis of net working capital tends to be on its efficient management and the minimisation of the net asset balance. Lower net working capital (NWC) means lower invested capital and higher return on investment. Reducing NWC improves liquidity and cash flow, and facilitates less debt financing or increased distributions to equity investors. It also reduces additional investment in future periods as a business grows, which should therefore have a positive impact on free cash flow and a DCF valuation.
The following extract from the financial statements of French car parts supplier Forvia, shows some typical cash flow focused analysis of working capital (including the impact of factoring, which we will consider later).
Forvia cash flow and related explanations (extract)
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Forvia 2024 financial statements
Any action to reduce receivables, increase payables, and therefore reduce net working capital, would seem to be a positive signal for investors. The problem is that this may not be the case, and analysing NWC only from a cash flow and invested capital perspective misses an important aspect – the impact on leverage and financial risk.
Financial leverage results in increased risk for equity investors, as commonly represented by equity beta, and a higher cost of equity. Investors usually think of financial leverage as being determined solely by debt financing. However, you should look beyond net debt – in our view, receivables and payables can be just as important. Reduced investment in NWC is generally positive from a returns perspective, but this gain may be offset by a loss in value due to the impact of higher leverage.
Receivables, payables and financial risk
Trade receivables are financial assets that, in effect, represent a lending arrangement. While the decision to grant credit to customers is connected to the operational management of a business, it is also a decision to lend. In many cases the lending aspect can be ignored because the amounts involved are not significant compared with, say, enterprise value, or because comparable companies have similar investment in working capital and any adjustments would not affect relative values.
Lack of interest income and expense due to an accounting ‘practical expedient’
There is also a financial reporting incentive to treat receivables (and payables) as part of net operating assets, which is to maintain consistency with performance metrics. When a sale with deferred payment terms is initially recognised, the full invoice amount is usually reported as revenue and as a receivable. This does not strictly comply with the principles of accounting, but is a ‘practical expedient’ granted by accounting standards to simplify financial reporting. Receivables, being a financial asset, should really be initially recognised at fair value1IFRS 9 Financial Instruments requires that all financial instruments should initially be recognised at their fair value. US GAAP does not follow the same approach but the outcome in terms of the measurement of receivables is the same., which would require measuring revenue and the receivable at the present value of the invoice price and the recognition of interest income when the customer settles the debt.
Obviously, if trade credit is relatively short (and interest rates low) the difference between the invoice price and present value will be small and, it is argued, the discounting and initial measurement at fair value is not worth the added effort. IFRS 15, which deals with accounting for revenue recognition (and the equivalent in US GAAP), only requires companies to discount the invoice price when the amount is due after more than one year. In practice, most receivables are not discounted, and no explicit interest income is recognised. Only if a company has a dedicated customer finance operation (such as car manufacturers) are you likely to see significant discounting and interest income, in which case this ‘banking’ type activity will likely be reported as a separate business segment anyway.
A similar approach is applied to purchases and trade payables, with the vast majority of these also not discounted and no explicit interest expense recognised.2Unlike for sales and receivables, here is no 12-month practical expedient rule for purchases and trade payables. However, most companies seem to apply the same approach. The same also applies to contract assets and liabilities that arise from revenue recognition accounting.3Contract assets arise when a company has satisfied a performance obligation (transferred goods or services to a customer), is entitled to payment, but has not yet billed the customer. Contract assets are therefore very similar to receivables and have similar economic effects regarding financial leverage. Contract liabilities represent advanced payments by customers and have an economic effect similar to trade payables.
If these working capital items are measured at a present value, an explicit interest amount appears in profit and loss. Investors need to be careful to identify whether this is part of operating profit to ensure that metrics such as EV/EBITDA are consistent. Under IFRS 18 (which will affect presentation from 2027) receivables interest income will be part of operating profit but payables interest expense will be reported as a component of the net financing expense.
Interest income and expense is implicit in all credit arrangements
The fact that there is no explicit interest income or interest expense recognised for most receivables and payables does not mean the economic effect is absent. Interest is still implicit in these transactions – it is simply incorporated into revenue and expenses.
To illustrate, suppose a company sells goods for 1,000 on 90 days credit – in the financial statements, revenue and a receivable of 1,000 are recognised. Had the receivable been recognised at fair value (and assuming a discount rate of 5%) the amount of revenue would have been 988, with interest income of 12 accruing over the 90 days. When the full invoice price is recognised as revenue, interest income is in effect still present, it is just implicit in the sales price and is included in the reported revenue.
While the interest of 12 in our above example may seem relatively small at only 1.2% of revenue, one needs to consider this not just relative to gross revenue but also relative to other metrics in financial statements. Suppose in our example the company has a relatively small operating profit margin of 10%. The implicit interest is now 12% of operating profit and its classification as part of operating profit rather than as a financial return has a greater impact.
We think that following the accounting approach to receivables and payables and treating them as operating items is fine in many cases. However, where the lending is significant relative to the operating business, or where different financing policies are applied by different companies, such as the factoring and reverse factoring we describe below, ignoring the separate risk and return characteristic of lending to customers can distort the metrics used in your analysis.4In our view the financial reporting 12-month practical expedient for companies to avoid discounting receivables and payables is too generous. It would be better to apply a simple materiality threshold, which should result in consideration of other factors, such as operating margin.
Treating receivables and payables as ‘financing’
Despite the accounting, there is no reason why you should not separate the activity of lending to customers and borrowing from suppliers from the rest of the operating activities of a business. Where the effect is material, we think doing so can provide additional insights and more relevant and comparable valuation metrics.
A greater proportion of lending assets reduces average asset risk
Lending assets generally have a significantly lower risk profile than an operating business. This can easily be observed in bond markets or the ability of banks to operate with much less capital relative to total assets than other businesses. Companies with a greater portion of value tied up as receivables should have a lower equity beta, lower asset beta and lower weighted average cost of capital. This impacts DCF valuations through the discount rate, and also impacts valuation multiples considering the link between risk, required return and value.
The opposite effect applies to trade payables. These, in effect, represent borrowing from suppliers with a similar impact on equity risk as debt finance. If asset betas are calculated based only on financial leverage, as represented by debt finance, then the leverage arising from payables remains as part of asset risk.
To illustrate, we compare the working capital, valuation multiples and risk (as measured by beta) for two European Auto Parts companies Forvia and Schaeffler. These companies have a notable difference in trade payables less trade receivables, which is also significant relative to market capitalisation and enterprise value, and which should therefore impact key valuation metrics.
Forvia and Schaeffler – Selected working capital and valuation data
All data (except equity and asset beta) from Morningstar. Trade payables and receivables are from the most recent financials. Values current at February 3rd, 2026. Equity beta is based on 3 years of weekly price data. Asset beta is our estimate based on capital structure data available from Morningstar.
Forvia has higher leverage than Schaeffler, both in terms of regular net debt5The net debt of Forvia is not as high as it might appear given the market capitalisation and enterprise value data quoted by Morningstar. This is due to a significant non-controlling interest amount included in EV. Non-controlling interests is one of the sources of measurement uncertainty in EV multiple calculations – we have not validated the Morningstar data. and from the significant net trade payables balance. Both leverage effects contribute to the higher equity beta for Forvia. The leverage effect of net debt is removed in the EV/EBITDA and asset beta metrics, but the data for Forvia still shows a lower multiple and higher asset beta. Of course, there are many factors that contribute to the differences in these metrics (and both are also affected by measurement uncertainty) but one of those factors should be the different leverage effect arising from trade payables and receivables.
It is worth noting that Schaeffler has recently seen a significant re-rating, with the stock price more than doubling over the last 6 months. This is due to the market’s enthusiasm for its participation in the humanoid robotics market. While Forvia is a still a valid comparison, the data above for Schaeffler (particularly the historical beta figures) need to be considered in the light of these recent business developments.
Adjusting EV metrics to remove additional financial leverage
Although you could simply analyse these valuation metrics after subjectively allowing for the different working capital positions, we think that removing the effect of working capital leverage (in addition to that arising from net debt) can give a better basis for analysis. In our adjusted data below, we include trade payables and trade receivables in enterprise value and adjust EBITDA to remove the estimated interest expense or income that is implicit in reported EBITDA metrics. In the case of Forvia, EBITDA is increased to remove the implicit interest cost we attribute to its net trade payables balance.
Forvia and Schaeffler – Adjusted valuation data
The Footnotes Analyst estimates based on Morningstar financial statement and valuation data.
Note: Estimates of equity beta are historical, may have a statistical margin of error, and are highly dependent on the dataset that is chosen. The figures above may not reflect the true current level of risk. Our estimates of asset beta also depend on leverage and debt beta inputs. The calculations are designed to illustrate equity analysis techniques; they do not to provide definitive answers.
Including receivables and payables as financing items reduces the apparent EV/EBITDA based valuation premium of Schaeffler from 64% to 27%. It also produces an asset beta for Forvia that is now almost the same as that for Schaeffler. We think the different working capital positions of these companies clearly affects their valuation metrics and requires careful consideration by investors.
Although the above approach to analysis can be applied to any situation where there is a significant difference in trade payables and receivables, for some investors this might seem a step too far from the standard treatment of working capital as operating assets and liabilities. If that is your view, we think you have 3 options:
- Make no adjustments: It is perfectly possible to do your analysis based on receivables and payables as presented in the balance sheet being components of net operating assets. However, if no adjustments are made, there is the potential for returns metrics and valuation multiples to be less comparable. Companies with lower receivables and/or higher payables are more leveraged, have higher financial risk, a higher cost of capital and should trade on lower valuation multiples (all other things being equal). However, a difference in financial working capital is no different from other operational differences between companies, all of which need to be considered in valuation. You just need to be aware of the leverage effect implicit in working capital balances and use judgement to factor this into your analysis.
- Normalise receivables and payables: Rather than treat all receivables and payables as financing, you could identify only abnormal balances as financing components for inclusion in EV. For example, if a company obtains a longer credit period from its suppliers than its peers, treat only the excess amount as financing in nature (but remember to adjust operating profit metrics to remove the implicit financing expense for this component).
- Adjust only for off-balance sheet financing: Some differences in receivables and payables arise from bank financing related to factoring or reverse factoring, assuming this financing is not explicitly reported as bank debt in the balance sheet. If this off-balance sheet debt can be identified, adjustments can be made to net debt and to the reported receivables and payables.
Working capital financing
There are three situations where we think working capital financing can have a significant impact on financial leverage: factoring, reverse factoring and advanced customer payments. In each case, we think investors need to pay particular attention to the effects on risk and leverage, in addition to the usual cash flow analysis of working capital.
Factoring of receivables
A factoring or invoice discounting arrangement is where a company ‘sells’ their receivables to a bank and receives payment before the usual due date. The bank will pay the face value of the invoices less an interest charge for the effective lending and, subsequently, recovers the loan when the customer settles on the due date.
There are two methods of accounting by the seller, depending on whether the receivables qualify to be ‘derecognised’. Although the receivable may be legally sold to the bank, it only qualifies for removal from the balance sheet in accounting terms if the ‘risks and rewards of ownership’, such as the risk of default or late payment, have also been transferred.
If the receivables are not derecognised the cash received from the bank is reported as a liability and the receivables remain on the balance sheet. When the customer settles, the liability is repaid. Interest and fees – the difference between the invoice price and amount paid to the seller by the bank are recognised as an expense as they accrue. In this situation receivables-factoring represents a secured on-balance sheet debt and would be included in traditional measures of leverage. However, most factoring arrangements are structured to avoid on-balance sheet debt.
Factoring results in bank debt that is generally off-balance sheet
If the receivables qualify for derecognition, the payment by the bank simply reduces the receivable balance. The problem for investors is that the leverage and financial risk impact of factoring that is accounted for as a reduction in receivables is essentially the same as if debt had been raised. Reduced receivables has almost the same impact on financial risk as higher receivables coupled with higher bank debt.
We are not saying the accounting is wrong – if receivables have been transferred and are no longer the asset of the seller, it is right that they should not be on the balance sheet. However, it is important that investors are aware of how receivables have been impacted by the factoring arrangement. One of the reasons why Forvia has a net trade payables balance in the data above, and higher financial leverage as a result, is because it engages in factoring of its receivables.
Forvia receivable factoring disclosure extract
Forvia 2024 financial statements
The bank debt of €1,279m shown above is off-balance sheet in the sense that it is not reported as borrowings, but is very much still on-balance sheet in that it reduces trade receivables. In our view, the financial leverage due to reduced receivables is very similar to the financial leverage effect of increased borrowings.
Reverse factoring or supply chain finance
Although there can be a variety of structures, supplier finance arrangements typically involve the purchaser arranging for a bank to provide payment to its suppliers earlier than the stated invoice date. It is similar to a supplier obtaining early payment of its receivables through factoring or invoice discounting, except the arrangement is made by the purchaser – hence the name ‘reverse factoring’. Suppliers who sign up to the scheme can submit invoices to the nominated bank which, following approval by the purchaser, settles the amount outstanding after deducting an interest charge. The purchaser subsequently settles their obligation by paying the bank on the normal invoice due date.
Possible increase in trade payables if supplier finance facilitates longer credit terms
These arrangements help a company’s suppliers by providing them with liquidity (although they pay for this via the interest deduction). They also help the purchaser in an operational sense in that it may provide greater security of supplies, but it could also provide a financial benefit if it enables the purchaser to negotiate longer credit terms than it otherwise would have done.
Although supplier finance arrangements involve bank financing, only rarely will either of the two parties involved report any debt finance in its balance sheet. In almost all cases the arrangement will result in a reduction in net working capital of one or both companies.
From the supplier perspective, reverse factoring is precisely the same as factoring, except that it only applies to certain customers and therefore may have less impact. The accounting is also the same, although the structure almost certainly means the receivables of the seller qualify for derecognition.
For the purchaser, a reverse factoring arrangement does not ordinarily change the amount of its liability, or how it is presented. Although the purchaser has an obligation to pay the participating bank, the liability will still be presented as a trade payable in its financial statements if the term of that payable is similar to what it would have been without the financing arrangement being in place. Only if the arrangement results in a significant extension to the normal credit period would the liability be reclassified as debt.
Arrangements usually structured to present a trade payable rather than a bank debt liability
Most companies structure these arrangements so that the liability remains as trade payables, and therefore avoid presenting additional financial debt on their balance sheet. However, considering that trade payables function in a very similar manner to regular debt, we think investors should consider the leverage effect to be similar, irrespective of the balance sheet classification.
Forvia has a reverse factoring programme under which it provides financing for its suppliers. There is no change in classification in the Forvia balance sheet, nor does it seem that the payables period has been affected. Indeed, in the disclosure shown below it seems that the creditors-days for suppliers in the scheme is lower than for others. Only if the reverse were true would we question whether the purchaser (Forvia) is using the programme to effectively obtain additional financing. Nevertheless, Forvia has a significantly longer creditors’ payment period than receivables collection period, which explains the difference in net payables balance compared with Schaeffler.
In our view the key feature for investors to focus on for equity valuation is the absolute amount of the trade payables (irrespective of how this is classified) and whether the supply chain finance arrangement has directly or indirectly increased the balance.
Forvia trade payables and reverse factoring disclosure extract
Forvia 2024 financial statements
Recent amendments to IFRS have resulted in enhanced disclosures about supply chain finance arrangements, which are reflected in the extract above. For more about analysing these disclosures, and for a model to illustrate how SCF impacts cash flow, see our articles ‘Leverage and cash flow effects of supply chain finance’ and ‘New supplier finance disclosures will affect operating cash flow’.
Advance payments by customers
In certain industries, particularly where property or capital goods take time to construct, it is common for customers to make advance payments. Where payments precede delivery, the seller reports a contract liability (which will become revenue when the performance obligation is satisfied) and also reports an increase in cash. The cash received may or may not remain as actual cash on the balance sheet – it could be used to fund construction, make advance payments to the company’s own suppliers, or simply form part of general financing of other net operating assets.
Deduct all cash balances in net debt, even if they result from customer advance payments
A question we have received many times from analysts is how to treat cash balances that result from advance customer payments, and whether it is appropriate to include this cash as part of net debt, rather than working capital, in enterprise value calculations. In our view, it is not the cash balance that requires careful analysis but rather the contract liability.
The contract liability that results from advance payments from customers has characteristics like trade payables. Higher contract liabilities also increase financial leverage. If the cash received remains as cash in the balance sheet, the leverage effect of the liabilities is negated, but if the cash has been applied to fund the operating business, both equity and asset risk will be increased.
In our view you should include any cash balances in the net debt calculation irrespective of whether they arose from advance customer payments or not. If the cash has been applied for other purposes, there is simply nothing to be deducted from debt. We think that investors should focus on the contract liability due to the additional financial leverage it produces, using the techniques we explain above.
Insights for investors
- In addition to analysing the cash flow and liquidity effects of working capital, consider the financial leverage impact of trade receivables, trade payables, contract assets and contract liabilities.
- Treating payables and receivables as financing rather than operating items can produce additional analytical insights and more comparable metrics.
- Remember to adjust operating profit and EBITDA to remove the implicit interest expense or income if payables and receivables are regarded as financing in equity analysis.
- Factoring and reverse factoring usually affect receivable and payable balances rather present as bank debt in financial statements; however, the leverage effects are similar.
- Advance customer payments may result in additional cash balances. Include these in net debt, but remember that the contract liability is also, in effect, debt and increases financial leverage.