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Hi Sir, This is the Example of Kaplan book which I can’t understand the answer of it:-
Edden Sales are 16M p.a and average receivables are are 3.3M p.a Which Represents 75 days of sales, It is now Considering a factor arrangment where 80% of book value of invoices is paid immediately with finance cost charged on a d v a n c e at 10% p.a
Suppose that this factor will charge 1% of sales as their fee for managing the sales ledger, that there will be administrative savings of $100,000 but outstanding balance will be paid after 75 days as before
Required : Determine relative Cost and Benefits of using the factor
Note 1): this is the second part of question as part b) & I done part a) in which cost of finance was 8%, I wrote this because answer of part b) is confusing, it is also using the previous cost of finance as OverDraft i.e 8%
Note 2) In answer they are using Recievables as book value of invoices i.e 3.3M p.a but not Sales which are 16M p.a, Why that so it must be 80% of 16M not 3.3M?
The overall cost of the finance will still be 8% – the factor is only advancing part of the receivables, the will still have to wait for the rest. The amount advanced by the factor is costing 10% ( or, if you prefer, an extra 2% ).
With regard to taking 80% is sales! it is not just the year end receivables that will be factored. The factor will be advancing 80% of all sales om credit throughout the year.
I also Thought that it must be sales but in kaplan the answer is very strange it is:-
COST OF FACTORING:
Sales Ledger Administration 16M x 1% = $160,000
Cost of Factor Finance 10% x 80% x $3.3M = 264,000SAVINGS:
Administration Cost Savings = $100,000
Overdraft Finance Costs 8% x 80% x $3.3M = 211,200Net Cost of Factoring = Cost of Factoring – Savings = 424,000-311,200
= (112,800)Sorry – what I wrote before was wrong.
Although 80% of all sales of 16m will be advanced, the interest will only be charged for 75 days (at the rate of 10% per annum).
75 days at 10% of 80% of 16M will be the shames as 10% of 80% of 75 days sales (which is 3.3M)Aah so you mean to say that this calculated as 75/365 x 16M x 80% x 10% ? and interest is charged because full book value of invoices were not paid right? if it were 100% fully paid then interest will not be charged right? and why they took overdraft finance cost 8% ?
Your first line is correct.
However the factor is charging interest because they are advancing money. It is still taking them 75 days to collect the money, but they are effectively lending the company 80% of the money early.
The other 20% is still being collected, (and will be paid to the company) but for his 20% the company has to wait the full 75 days (which is why it is costing them 8% overdraft interest).Oh I see, That means they are deducting 2% extra Interest Charge on a d v a n c e and the 8% is the nominal rate of interest which is charged on the money which will be collected after 75 days, then deducting both will give us Cost or Benefit, T h an k you sir I finally Understood 😀
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