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Question 32
Hi Mr JohnA- Why don’t we add 2% of bad debt in option 1 ? ( They only add bad debt in option 2 )
B- why don’t we add 9% of the interest rate in option 2 ? as this is also financing cost ?
C- why do they add 2% of bad debt when calculating the increase in finance cost ? ( I mean it should be only 2,301,370* 0.80) .
As I simply think the company hire the factor to save that 2% . So I don’t understand why we need to count that 2% as cost here .
Thank you Mr JohnA: The factoring in Option 1 is on a with-recourse basis and so the company still suffers the bad debts. The factoring in Option 2 is on a non-recourse basis and so the factor suffers the bad debts – the company does not suffer any bad debts.
I explain the difference in my free lectures on the management of receivables.B: The 9% is a financing cost but at the same time the receipts in advance are saving 7% overdraft interest and therefore there is just the extra cost of 2% as in the answer.
C: I don’t understand what you mean. The increase in the financing cost is (as per what I have written in B) 2% of 2,301,370 x 0.80. The 2% is nothing to do with the bad debts, it is the extra interest cost.
And no, in option 2 they are paying the factor to improve receivables management, to remove the bad debts, and to provide finance earlier.
Have you watched my free lectures on this?
Hi John,
In option 1 question above : Should the company then include 2% of bad debt as a cost because its the company who will be bearing it and not the factor ?The are already suffering the bad debts and so there is no extra cost involved if it is with recourse factoring.
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