Problems with Solutions for Practice in Factoring – by Rahul Krishna

FACTORING PROBLEMS &038 SOLUTIONS 1. pic pic 2. A go with is holding engaging a ingredient, the following information is available i) The current average collection block for the Companys debtors is 80 days and ? % of debtors default. The doer has agreed o pay money due after 60 days and go away take the responsibility of any loss on account of heavy(a) debts. ii) The yearbook charge for the meansisation is 2% of turnover payable per stratum in arrears. Administration represent saving is likely to be Rs. 1,00,000 per annum. iii) yearbook gross revenue, altogether on assign, ar Rs. ,00,00,000. Variable price is 80% of sales price. The Companys cost of borrowing is 15% per annum. Assume the year is consisting of 365 days. Should the Company enter into a factoring agreement? pic 3. MSN Ltd. has total sales of Rs. 4. 50 crores and its average collection period is 120 days. The past assure indicates that drab debt losses are 2 percent on sales. The spending incu rred by the connection in administering its receivable collection efforts are Rs. 6,00,000. A Factor is wide-awake to buy the companys receivables by charging 2 percent commission.The factor go out pay pass on on receivables to the company at an interest treasure of 18 percent per annum after withhold 10 percent as reserve. You are infallible to calculate powerful cost of factoring to the company. pic pic 4. The turnover of PQR Ltd. is Rs. 120 lakhs of which 75 per cent is on source. The variable cost ratio is 80 per cent. The recognition terms are 2/10, net 30. On the current level of sales, the bad debts are 1 per cent. The company spends Rs. 1,20,000 per annum on administering its credit sales. The cost includes salaries of staff who wish credit checking, collection etc. These are avoidable cost.The past populate indicates that 60 per cent of the customers avail of the funds discount, the remaining customers pay on an average 60 days after the appointment of sale. Th e Book debts (receivable) of the company are presently beingness payd in the ratio of 1 1 by a mix of bank borrowings and owned funds which cost per annum 15 per cent and 14 per cent respectively. A factoring self-coloured has crannyed to buy the self-coloreds receivables. The main elements of such deal integrated by the factor are (i) Factor reserve, 12 per cent (ii) Guaranteed payment, 25 days (iii) Interest charges, 15 per cent, and (iv) Commission 4 per cent of the honour of receivables.Assume 360 days in a year. What advise would you give to PQR Ltd. whether to incubate with the in house management of receivables or accept the factoring watertights put up? picpic 5. A firm has a total sales of Rs. 12,00,000 and its average collection period is 90 days. The past experience indicates that bad debt losses are 1. 5% on sales. The expenditure incurred by the firm in administering receivable collection efforts are Rs. 50,000. A factor is prepared to buy the firms receivabl es by charging 2% commission. The factor leave alone pay advance on receivables to the firm at an interest rate of 16% p. a. after withholding 10% as reserve.Calculate telling cost of factoring to the firm. Assume 360 days in a year. picpic 6. The credit sales and receivables of M/s M Ltd. at the end of the year are estimated at Rs. 3,74,00,000 and Rs. 46,00,000 respectively. The average variable overdraft interest rate is 5%. M Ltd. is considering a proposal for factoring its debts on a non-recourse bag at an annual fee of 3% on credit sales. As a result, M Ltd. leave alone only Rs. 1,00,000 per year in administrative cost and Rs. 3,50,000 as bad debts. The factor will maintain a receivables collection period of 30 days and advance 80% of the verbal expression value thereof at an annual interest rate of 7%.Evaluate the viability of the proposal. Note 365 days are to be taken in a year for the purpose of calculation of receivablespicpic 7. Junio Limited is a abject manufactur ing company which is suffering cash flow problems. The company already utilizes its level best overdraft facility. Junio Limited sells an average of Rs. 4,00,000 of goods per month at invoice value, and customers are allowed 40 days to pay from the date of invoice. Two possible solutions to the companys cash flow problems have been suggested. They are as follows Option 1 Junio Limited would factor its trade debts.A factor has been found who would advance Junio Limiteds 75 percent of the value of the invoices immediately on receipt of the invoices, at an interest rate of 10 percent per annum. The factor would also charge a service fee amounting to 2 percent of the total invoices. As a result of using the factor, Junio Limited would save administration costs estimated at Rs. 5,000 per month. Option 2 The company could offer a cash discount to customers for prompt payment. It has been suggested that customers could be offered a 2% discount for payments made within ten days of invoic ing.You are indispensable to (a) Discuss the issues that should be considered by management when a policy for credit go out is formulated. (b) Identify the services that whitethorn be provided by factoring organizations. (c) Calculate the annual net cost (in Rs. ) of the proposed factoring agreement. (d) Compute the annualized cost (in percentage terms) of offering a cash discount to customers. (e) Discuss the merits and demerits of the cardinal proposals. (a) Policy for Credit Control for Junio Limited (a) When a policy is being formulated, management should consider the following issues i) The average period of credit to be given. Whether this should be longer than average to encourage sales or less(prenominal) than average, to speed up sales. (ii) Policy for making decisions on granting credit to item-by-item customers How customers are to be investigated for creditworthiness? (e. g. by direct judicial decision by the company, or indirect assessment using credit references from banks, or other assessment agencies) How the amount and timing of credit is to be decided? (e. g. whether credit is to be increased progressively). (iii) Debt collection policies Whether to employ specific people for this work.Issue of debtors statements, varan letters, whether and when to bedevil use of professional debt collectors and when to consider legal action. (iv) Accounting reports required Aged debtors lists etc. (v) Polices on persuading debtors to pay promptly Discount schemes. (vi) Whether to make use of factoring services. For all the above, it will be necessary to consider the costs and benefits of the alternative course of action. This will include considerations on how credit is to be financed. (b) A factor normally manages the debts owed to a leaf node on the clients behalf. Services Provided by Factoring Organisations i) Administration of the clients invoicing, sales accounting and debt collection service. (ii) Credit protection for the clients debts, w hereby the factor takes over the risk of loss from bad debts and so insures the client against such losses. The factor may purchase these debts without recourse to the client, which elbow room that if the clients debtors do not pay what they owe, the factor will not ask for the money back from the client. (iii) Factor finance may be provided, the factor advancing cash to the client against outstanding debts. The factor may advance up to 85 percent of approved debts from the date of invoice. iv) A confidentiality agreement may be offered to conceal the existence of the arranging from customers. (c) Calculation of Annual Cost of Factoring It is assumed that the factor finance will not replace any existing credit lines, and therefore, the ripe interest cost of the agreement will be relevant when ascertain the cost of factoring. Annual Sales = Rs. 4,00,000 ? 12 = Rs. 48,00,000 Daily Sales = Rs. 48,00,000/365 = Rs. 13,151 The annual cost of factoring can now be found pic pic (e) bri ng out Issues in the Discounting Option (i) The proposal is expensive.The company should be able to ca-ca cheaper overdraft finance than this, and longer-term debt should cost even less. (ii) The company may need to offer a discount in order to make its terms competitive with other firms in the industry. (i) The level of take-up among customers is uncertain, and will affect the cash flow position. (ii) Problems may arise when customers take both the discount and the full moon forty day credit period. This will increase administrative costs in seeking repayment. Key Issues in the Factoring Option (i) The factor may be able to exercise better credit control than is possible in a small company. ii) The amount of finance that will be received is much more certain than for the discounting option as 75 percent of the value of the invoices will be provided immediately. (iii) The relationship with the customers may deteriorate partly due to the reduction in the level of cut off with the company, and partly due to the historical view of the factor as the lender of last resort. Thus, the final decision must take into consideration all the above issues. However, the most important points to consider are the ability of severally proposal to meet the financing requirements, and the relative costs of the different sources of finance.