We penalise companies with a high and/or rising level of payables relative industry peers. For the purposes of our analysis, we have used two ratios: payables as a percentage of sales and of Cost of Goods Sold (COGS). The reason we include both is that some companies are not required to report their COGS and so the more traditional Payable Days metric fails to populate.
We penalise companies with high and/or rising payables relative to industry peers. The speed at which a company pays its suppliers is more likely dictated by the industry that it operates in than its domicile, although sometimes cultural considerations are important. For example, Italian and Spanish companies took twice as long to pay their suppliers between 2010 and 2015 (at 20% of sales) than Thai and Russian ones (at less than 10%). Most industries pay their suppliers within 36-55 days, in other words payables are 10-15% of sales, as shown in Figure 41. Presumably, problems in Italy and Spain are related to corporate insolvency in the aftermath of the Global Financial Crisis. Industries with larger payables tend to be those with longer production times, such as construction and real estate, while those with smaller payables have shorter production times, such as retailers.
Large payables are not always problematic and could suggest that a company has simply managed to negotiate excellent supplier payment terms. However, in some instances debt is disguised as payables in order to make leverage ratios look lower than reality. In this instance, management might fail to disclose interest expenses to their auditor. Furthermore, a rising payable leads to an increase in operating cash flow which may flatter other operating cash flow based metrics. As such, investors should be wary or large and rising payables.
Our accounting screen is set to trigger a red flag when payables exceed the 80th percentile (i.e. they are very high) relative to GICS industry peers, and/or when there is an abnormally large increase relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in payables exceeds the 80th percentile relative to the change experienced by industry peers between 2010 and 2015.