Question

Super Smart Clothes Ltd has annual, non-seasonal credit sales of R3 200 000. Customers are expected to pay within 30 days, but in fact have been settling in an average of 42 days. Super Smart Clothes experiences a bad-debt rate of 0.8% of debtors annually. The company’s current overdraft facility is 2.5% above base-rate, which is at present 12%. Unfortunately, the overdraft limit has nearly been reached, and is unlikely to be extended. Super Smart Clothes Ltd has contacted We Help You Ltd, a factoring firm, and has been quoted:

• A factor charge of 1.8% of credit sales (Super Smart Clothes Limited estimates that this would save R25 000 administration costs per year)
• An advance of 75% of invoices at 3% over base-rate.

Required:

Should the factoring firm, We Help You Limited, terms be agreed to?

Answer 1

Credit Sales	3,200,000.00
Average Credit Period	42	days
Annual Cost:
Cost of credit = 3,200,000 x 42/365 x (12%+2.5%)	53,391.78
Bad Debts = 3,200,000 x 0.8%	25,600.00
Administration Cost	25,000.00
Total Cost	103,991.78
Cost of Factor:
Factor's Finance = 30/365 x 3,200,000 x 75% x (12%+3%)	29,589.04
Overdraft = 30/365 x 3,200,000 x (1-75%) x 14.5%	9,534.25
Cost of Factor services = 3200000 x 1.8%	57,600.00
Cost of Factor	96,723.29
The factor is cheaper overall because it will be more efficient in collecting debt. The advance of  75% of debt is not needed however cost of factor 15% is higher than company's overdraft rate of 14.5%.