Debtor factoring is not like an overdraft facility

“Our business is not insolvent,” remarked Scotty, “we have plenty of room in the limit of our debtor factoring facility and we made a small profit last year.”

Let me know what you think about this in the comments, because I have heard it 3 times just this week. Do I think this is right? If working capital is already poor, then no.

Scotty refers to two indicia: (1) ability to draw down more from factoring; and(2) profitability.

1. Factoring – even if there was a surplus, it’s not relevant to the question of solvency. Why?

– by factoring, the company is reducing accounts receivable and exchanging that current asset for a slightly reduced other current asset (ie cash) and a current liability (ie the loan to the factoring company);

– this exchange is akin to just exchanging short-term obligations, without improving cash flow (Harrison v Lewis; ASIC v Edwards); and

– the real kicker: in contrast to an overdraft facility, the company would actually have had to sell more products/services than it actually did to utilise the surplus (in hindsight). That’s impossible!

2. Profitability – courts recognise that big profits, which could foreseeably pay all debts in the reasonable future, are a sign of solvency (Quick v Stolan, 379-380).

Sorry Scotty.


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