Question

A factoring company has proposed a one-year agreement to Faith Ltd. to both manage its receivables and advance 80% of the credit sales value when invoiced. Existing invoices will be eligible for an immediate 80% cash payment. The annual sales on credit by Faith Ltd. are K6m spread evenly throughout the year, and the average delay in payment from the invoice date is 90 days. The factoring company is confident of reducing this delay to only 60 days, and will pay the remaining 20% of invoice value to Faith Ltd. immediately on receipt from the customer. The charge for receivables management will be 1.7% of annual credit turnover payable at the year-end. For the advance payment on the invoices a commission of 1% will be charged plus interest applied at 10% per annum on the gross funds advanced. Faith Ltd. will be able to save K80,000 during this year in administration costs if the factoring company takes on the debtor management. Currently, the company finances trade credit through an overdraft facility with an annual interest rate of 11%. Required: Draft a letter to the Directors of Faith Ltd. advising them on whether to enter into the agreement. Your letter should include: (i) A table showing the results of your calculations. Include any detailed workings on a separate page as an appendix to your letter, and (ii) A brief discussion of the relative advantages and disadvantages of bank overdraft.

Answer 1

1)

The management need to decide after analysis of cost and benefits from the agreement, whether accept or reject the agreement.

The saving from the agreement is as follows:

Resultant table:

The net benefit from the agreement is as follows:

Resultant table:

The reslut of the agreement is $13,000 in positive, so the management should accept it.

2)

Overdraft facility

The advantage of overdraft facility is as follows:

•           Provide immediate finance for the working capital

•           Help in expanding the business

•           Easy access to overdraft facility

The advantage of overdraft facility is as follows:

•           Regular interest payment

•           Risk of security (stock and debtor) forfeited and sold by bank.

•           If the overdraft facility is not utilized properly, it creates liquidity risk

Compliance with bank guidelines distracts the organization from their goals.