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A Company has credit sales of 200,000pa. Credit term is 30 days. The factor offers to buy 80% at an interest rate of 9%. The company can get an overdraft for 6%. The factor charges 1.5% of current credit sales.
The factor will offer customers an early settlement discount if paid in 15 days, 40% will accept this and the remainder will take 50 days to pay. Sales will increase by 5% and contribution to sales ratio is 40%
Cost of Factoring
New receivables = New sales x 15/365 x 40% = 3,452
New receivables = New sales x 50/365 x 60% = 17,260
Financed by overdraft cost at 6% = 1,242
Factor Fee = 200,000 x 1.5% = 3,000
Increase in contribution = sales increase x 40% = (4,000)
Forward Cost = new receivables x 80% x (9-6%) = 497.10TOTAL = 739.1
Q1) Sir Please what does “The factor offers to buy 80% at an interest rate of 9%” mean?
Q2) Why did they use (9-6%) to have the forward cost?In future you must ask in the Ask the Tutor Forum if you want me to answer – this forum is for students to help each other.
Q1. The factor gives the company 80% of the receivables immediately (so the company does not have to wait for the money as they otherwise would have to).
Q2 The factor charges 9% interest on the money they give the company. However the company is saving 6% interest because getting the money immediately means a lower overdraft and therefore lower overdraft interest.
All of this is explained (with examples) in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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