debt factor financing

Hi Jatin,

As far as the F9 syllabus is concerned your requirement between now and the exam is clear and simple: make sure you know (1) the DEFINITION of Debt Factoring (2) the 3 LEVELS OF SERVICE normally available (3) the ADVANTAGES and DISADVANTAGES of Debt Factoring (4) be able to describe and compare INVOICE DISCOUNTING versus DEBT FACTORING …. no more / no less is required !

As for your specific question, which I have to say is really beyond the scope (or at best on the very periphery) of the F9 syllabus, Debt Factor Finance is generally classified as “Off-Balance Sheet“.

However, some debt factoring arrangements can be quite clever and complex and so the precise and final treatment in the accounts, either within or off the balance sheet, will really be dependent on the specific circumstances of the deal entered into with the factor vis a vis a “true and fair” view being presented by the accounts.

Just like, for example “Sale and Leaseback” and/or “Operating Leases”, it is possible for the Directors to legitimately increase the company’s LIQUIDITY through the means of Debt Factoring.

However, manipulation or mis-representation is also possible, especially when off-balance sheet financing is used to deliberately remove the transparency that shareholders, other investors, the markets and regulators have come to expect from the financial accounts – perhaps in order to achieve tax benefits or improve gearing ratios for funding purposes (in order to remain within the terms of debt covenants).

Information relating to the use of debt factor finance is normally required to be given in notes to the company’s annual accounts. The nature and extent of the disclosure depends on the materiality and purpose of the debt factoring arrangement entered into by the company and on other specific circumstances relating to the size of the company, etc.,.

At this point we have clearly departed from our F9 remit and so I shall leave the matter to rest here. Suffice it to say that the disclosure of off-balance sheet activities can be quite technical and complex and may I therefore suggest that any further questions you may have on this particular funding arrangement are probably better addressed within the Financial Accounting and/or Auditing Forums …. .

As a final point, it is worth noting that “Creative Accounting” is a real-world phenomenon. Interestingly, the F9 syllabus features regular exam questions on the closely related topic of “Market Efficiency”.

The Semi-Strong Form of stock market efficiency is the generally accepted view and under this view one would expect that any form of “creative accounting” would have no impact on a company’s share price.

The information content of the accounts is assumed to have been quickly and accurately reflected within the share price immediately upon publication of the accounts. However, BRILOFF (the Briloff Factor) proved otherwise – when he disclosed the existence of creative accounting within the published accounts of McDonald’s the share price immediately reacted violently… However, according to the accepted (normal) view of semi-strong market efficiency this should not have happened!

Regards, Kevin Kelly

HI Jatin,

I would be more inclined to describe the 3 levels as follows:

There are 3 levels of service – each for a progressively higher fee.

Administer Sales & Debtors Ledgers
– Administration of Sales and Debt Collection includes:
– Assess Customer Credit Worthiness
– Set Customer Credit Terms and Settlement Discounts
– Manage Customer Credit Control Systems
– No Bad Debt Insurance – the company retains responsibility for any bad debts.

Advance Finance – with Recourse
– Advance, say, up to 80% of sales values immediately upon invoicing
– The company remains responsible for any Bad Debts, i.e. No Bad Debt Insurance

Advance Finance – without Recourse
– As above (with recourse) but this time the factor accepts responsibility for any Bad Debts , i.e. Bad Debt Insurance

Regards, Kevin Kelly