Which of the following statements is/are correct?
(1) Factoring with recourse provides insurance against bad debts
(2) The expertise of a factor can increase the efficiency of trade receivables management for a company
A. 2 only
B. 1 only
C. Neither 1 nor 2
D. 1 and 2
The finance director of Widnor Co has been looking to improve the company’s working capital management. Widnor Co has revenue from credit sales of $26,750,000 per year and although its terms of trade require all credit customers to settle outstanding invoices within 40 days, on average customers have been taking longer. Approximately 1% of credit sales turn into bad debts which are not recovered.
Trade receivables currently stand at $4,458,000 and Widnor Co has a cost of short-term finance of 5% per year.
The finance director is considering a proposal from a factoring company, Nokfe Co, which was invited to tender to manage the sales ledger of Widnor Co on a with-recourse basis. Nokfe Co believes that it can use its expertise to reduce average trade receivables days to 35 days, while cutting bad debts by 70% and reducing administration costs by $50,000 per year. A condition of the factoring agreement is that the company would also advance Widnor Co 80% of the value of invoices raised at an interest rate of 7% per year. Nokfe Co would charge an annual fee of 0·75% of credit sales.
Assume that there are 360 days in each year.
Required:
(a) Advise whether the factor’s offer is financially acceptable to Widnor Co. (7 marks)
(b) Briefly discuss how the creditworthiness of potential customers can be assessed. (3 marks)
Extracts from the recent financial statements of Bold Co are given below.
| $000 | ||
| turnover | 21300 | |
| cost of sales | 16400 | |
| ------- | ||
| gross profit | 4900 | |
| ------- | ||
| $000 | $000 | |
| non-current assets | 3000 | |
| current assets | ||
| inventory | 4500 | |
| trade receivables | 3500 | |
| ------- | ||
| 8000 | ||
| ------- | ||
| total assets | 11000 | |
| ------- | ||
| current liabilities | ||
| trade payables | 3000 | |
| overdraft | 3000 | |
| ------- | ||
| 6000 | ||
| equity | ||
| ordinary shares | 1000 | |
| reserves | 1000 | |
| ------- | ||
| 2000 | ||
| non-current liabilities | ||
| bonds | 3000 | |
| ------- | ||
| 11000 | ||
| ------- |
A factor has offered to manage the trade receivables of Bold Co in a servicing and factor-financing agreement. The factor expects to reduce the average trade receivables period of Bold Co from its current level to 35 days; to reduce bad debts from 0·9% of turnover to 0·6% of turnover; and to save Bold Co $40,000 per year in administration costs.
The factor would also make an advance to Bold Co of 80% of the revised book value of trade receivables. The interest rate on the advance would be 2% higher than the 7% that Bold Co currently pays on its overdraft. The factor would charge a fee of 0·75% of turnover on a with-recourse basis, or a fee of 1·25% of turnover on a non-recourse basis.
Assume that there are 365 working days in each year and that all sales and supplies are on credit.
Required:
(c) Calculate the value of the factor’s offer:
(i) on a with-recourse basis;
(ii) on a non-recourse basis. (7 marks)
(d) Comment on the financial acceptability of the factor’s offer and discuss the possible benefits to Bold Co of factoring its trade receivables.