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Gasoline Plc a main market provider for buying and selling gas in bulk in the UK market.Currently the credit control department is poorly managed due to the resignation of its credit controller which therefore affect its credit control policy.Overdraft balance currently amounts to $5million compared to $1.5million last year.
The company is therefore considering factoring its debts to improve its cash flow and to reduce costs.Credit sales for last year totaled $8.5m with average trade receivables of $4.3m .Next year sales are expected to be 20% higher and receivables collection period to remain the same if the factoring
agreement is not entered into.A factoring company has put forward the following proposal to Gasoline Plc:
i) the factor would immediately advance 70% of the value of sales invoices
1) the factor would charge interest of 12% pa on the advances
iii) the factor would charge an administrative fee of 1.5% of sales revenue
iv) trade receivables collection period will be reduced to 60 days as a result of better management controlShould GasolinePlc enter into the agreement,it will make both the credit control staff redundant.They each earn salary of $14,000 p.a but they will both be paid a redundancy package of $3000 each.Current bank overdraft interest rate is 9%
Sir,can you help me with this?
Ans : The Company should factor its debt as the cost of factoring is lower by $53858 than not factoring
Presumable the answer in your book shows the workings, and so you should ask about which part of the answer you are not clear about and I will explain.
(I assume that you have watched my free lectures on the management of receivables? The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.)
Interest in lower receivables
Current receivables
(185/365 × 10200000) : 5169863New receivables
(60/365 × 10200000) : 1676712Reduction : 3493151
Interest(9%) : 314384
??Admin saved(14000×2) = 28000
Savings : 28000+ 314384 = 342384
This is what I calculated.
•Interest advance
Extra cost
(12-9) = 3% × 1676712 × 70%
= 35211Admin fee
(1.5% × (8.5m × 120%)) = 153000Redundancy
(3000 × 2) = 6000Cost : 35211 + 153000 + 6000
= 194211Net benefit = 342384 – 194211
= 148173I cannot compare my working with given answer because what im doing is calculating cost against savings,while the answer given gives me the calculations of the cost in doing Factoring or Didnt do Factoring
I am sorry for the inconveniences.
Is there any mistake at my calculations Sir.?
I agree with all of your workings apart from one.
Because the redundancy costs are a ‘one-off’ rather than ever year, you should bring in the yearly interest cost as $6,000 x 9% = $540.
However this is a minor point and does not make a big difference to your answer.
It would seem that the answer you originally quoted of $53,858 is wrong!!
(Are you sure that note (iv) of the question says that the collection period reduced TO 60 days, and not that it reduced BY 60 days? That would still not give the answer quoted but it would not be as much different 🙂 )
Where did you find the question? If it is a past exam question or a question from the BPP Revision Kit, then let me know so that I can investigate 🙂
Yes Sir ,the question quoted the collection period reduced TO 60 days.
The Answer given:
Factoring
Adm Fee 153000
Redundancy 6000
cost of financing
i)12% x (60/365x 10.2) X 70% =140844
ii)9%. × 30% x (185/365 X 10.2) = 139586Total cost=439430
No Factoring
Credit controller = 28000
Cost of financing TR = 9% × (185/365 × 10.2)
=465288
Total cost= 493288~Therefore,the company should Factor their debt as it saves $53858
Assuming, obviously, that you have copied the wording of the question correctly, then the answer given is wrong (and what you did was correct, subject to the point about the redundancy).
The reason that the answer given is wrong for the factoring flows is that it has assumed that the 60 days collection period only applies to the 70% that the factor is advancing (and that the other 30% still take 185 days). That is not what the question says (and would be ridiculous anyway). The question says that the collection period is 60 days for all receivables – some of which the factor pays in advance and some the factor does not.
(The answer is also wrong with respect to the redundancy as I explained in my previous answer, although this is a minor point.)You did not say where you found the question.
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