Financial+Services+Factoring+Problem

7/28/2019 Financial+Services+Factoring+Problem

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Date: 23rd November

Evaluation of Factoring: Factoring Problems

In credit sales money is blocked. For such money, we had chance of getting money

using factoring.

In case of factoring, we had to pay commission, only some proportion of amount we

get. We had to decide either to go factoring or banker for loan with interest rate.

1. A firm furnishes you the following details:

Total Credit sales = Rs. 7500000 per annum

ACP (Avg collection period)= 60 days

Estimated bad debt losses = 1% of credit sales.

Current spending on credit administration Rs. 1 lakh per annum.

The firm is planning to approach a factor in order to finance its credits sales. A

factor charges 2% a commission and makes an advance at interest of 17%

retaining 10% as reserve. If the cost of a similar source of short term funds in

the market is 18%.

Advise the firm, whether to go for the factoring option or not. Set up year

calculations assuming 360 days.

Solution:

Evaluation there are 2 methods. 1. Net benefit method 2. Effective interest rate

method

1. Net benefit method:

Calculate all expenditure of factoring and banking and see the best low

expenditure

2. Effective Interest rate method:

Calculate based on interest rate.

Calculation or computation of effective factoring efficiency

Step 1: Calculate average account receivables level

360 Days 7500000


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60 Days ?

7500000 x (60/360) = Rs. 1250000 i.e., total credits sales *(collection

period/annum)

Step 2: ACP factoring commission

ACP Factoring commission: 2% * Rs. 1250000 = Rs. 25,000

Step 3: ACP Reserve

1250000 * (10/100) =Rs. 125000

Step 4: Gross advance

= step 1 (step 2 + step 3 ) =1250000 (25000+12500) = Rs. 11,00,000

Step 5: ACP interest on factoring advance

= 11,00,000*17% * (60/360) = Rs. 31,167

Step 6: Net factoring advance

= Gross advance - interest = 11,00,000 -31167 = Rs. 10,68,833

Till now have calculated till the time period of 60 days. Let us calculate for

annual basis

Step 7: ANNUALIZED FACTORING COMMISSION

75,00,000 * 2% = Rs. 1,50,000

Step 8: ANNUALIZED INTEREST CHARGES

60 -> Rs. 31,167

360 ?

= (360/60) x 31167 = Rs. 1,87,000

24th Nov 2009

Step 9: Total Annual Factoring Cost

= AFC + Annual Interest charges = 150000+ 187000 = Rs.

3,37,000

Step 10:


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In-house credit expenditure =1,00,000

Step 11: Bad Debts Losses avoided= 1% x75,00,000 = Rs. 75,000

Step 12: Total In-house credit administration expenditure

= 1,00,000 +75,000 = Rs. 1,75,000

Step 13: Net Factoring Cost

= Step 9 Step 13 =

Total Annual Factoring Cost - Total In-house credit administrationexpenditure = Rs. 1,62,000

Step 14: Net Benefit Method:

i) Alternative source = Gross Advance x interest rate of bank = 11,00,000 x

18% = Rs. 1,98,000

ii) Alternative sources Factoring cost = 198000-162000 = 36,000

Note: If net benefit is negative then better to borrow from bank

Step 15: Effective Interest Rate Method

= (Net Factoring cost x 100)/ Net Factoring advance= (1,62,000 x 100)/ 10,68,833

= 15.16%

Hence, it is better to go for factoring than borrowing from other sources like interest

rate from bank as interest rate of bank is 18%.



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23rd December 2009

A firm is considering engaging in order to be relived substantially from the risk of inhouse credit administration. You have been asked to examine the firms request in

this regard. The company furnishes you the following details.Total credit sales: Rs. 85 lakhsACP(Avg collection period ) = 90 daysEstimated bad debt losses 1% of credit sales.Current spending on credit administration: 1lakh rupees per annum.Factors commission 2%Factors reserve 18%Interest on advance = 15%.Cost of alternative sources = 19%Calculations are done assuming 360 days.

Solution:

Calculation or computation of effective factoring efficiency

Step 1: Calculate average account receivables level

360 Days 8500000

60 Days ?

8500000 x (90/360) = Rs. 2125000 i.e., total credits sales *(collection

period/annum)

Step 2: ACP factoring commission

ACP Factoring commission: 2% * Rs.2125000 = Rs. 42,500

Step 3: ACP Reserve

2125000 * (18/100) =Rs. 3,82,500


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Step 4: Gross advance

= step 1 (step 2 + step 3 ) =2125000 (42500+382500) = Rs. 17,00,000

Step 5: ACP interest on factoring advance

= 17,00,000*15% * (90/360) = Rs. 63,750

Step 6: Net factoring advance

= Gross advance - interest= 17,00,000 -63750 = Rs. 16,36,250

Till now have calculated till the time period of 90 days. Let us calculate for

annual basis

Step 7: ANNUALIZED FACTORING COMMISSION

85,00,000 * 2% = Rs. 1,70,000

Step 8: ANNUALIZED INTEREST CHARGES

90 -> Rs. 63,750

360 ?

= (360/90) x 63750 = Rs. 2,55,000

Step 9: Total Annual Factoring Cost= AFC + Annual Interest charges = 170000+ 255000 = Rs.4,25,000Step 10:In-house credit saved =1,00,000Step 11: Bad Debts Losses avoided= 1% x85,00,000 = Rs. 85,000 (saving)

Step 12: Total In-house credit administration saved

including bad debts

= 1,00,000 +85,000 = Rs. 1,85,000

Step 13: Net Factoring Cost

= Step 9 Step 12 =

Total Annual Factoring Cost - Total In-house credit administration

saving = Rs. 4,25,000 - 1,85,000 = 2,40,000

Step 14: Net Benefit Method:


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Cost of Alternative source = Gross Advance x interest rate of bank = 17,00,000 x

19% = Rs. 3,23,000

i) Net benefit method = Cost of Alternative sources Factoring cost =

3,23,000-240000 = 83000


rate from bank as interest rate of bank is 19% as interest is high.


Step 15: Effective Interest Rate Method

= (Net Factoring cost x 100)/ Net Factoring advance= (2,40,000 x 100)/ 16,36,250

= 14.67%


rate from bank as interest rate of bank is 19% as interest rate. Here factoringinterest rate is 14.67%

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Financial+Services+Factoring+Problem