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

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:

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 administration expenditure = Rs. 1,62,000 Step 14: Net Benefit Method:
i) ii) Alternative source = Gross Advance x interest rate of bank = 11,00,000 x 18% = Rs. 1,98,000 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%. Note: If net benefit is negative then better to borrow from bank

23rd December 2009 A firm is considering engaging in order to be relived substantially from the risk of in house 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 lakhs ACP(Avg collection period ) = 90 days Estimated 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

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. 4,25,000
Step 10: In-house credit saved =1,00,000 Step 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:

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

Hence, it is better to go for factoring than borrowing from other sources like interest rate from bank as interest rate of bank is 19% as interest is high. 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= (2,40,000 x 100)/ 16,36,250 = 14.67% Hence, it is better to go for factoring than borrowing from other sources like interest rate from bank as interest rate of bank is 19% as interest rate. Here factoring interest rate is 14.67%