CASE STUDY

CASE STUDY
The turnover of R ltd is Rs 60 lakhs of which 80% is on credit. Debtors are allowed one month to clear off the dues. A Factor is willing to advance 90% of the bills raised on credit for a fee of 2% a month plus a commission of 4% on the total amount of debts . R .Ltd as a result of this arrangement is likely to save Rs 21600 annually in management costs and avoid bad debts at 1% on the credit sales. A bank has come forward to make an advance equal to 90% of the debts at an annual interest rate of 18%.However ,its processing fee will be at 2% on the debts . Would you accept factoring or the offer from the bank

SOLUTION
Cost of factoring:Fee(0.02*0.90*400,000) Commission (0.04*400,000) Less: Saving in Cost Management Costs((Rs 21600/2) Savings in Bad debts(0.01* Rs 400,000) 7200(in Rs) 16,000 23,200 1800(in Rs) 4000 5800 17,400

Net cost of factoring Cost of bank advance: Interest (0.18*1/12*0.90*Rs 400,000) Processing fee(0.02* Rs 400,00) Bad debts(0.01*Rs 400,000) *(Annual credit sales Rs 48 lakhs/12)

5400 8000 4000 17,400

ASSUMPTIONS

It is assumed that R Ltd will continue to incur management costs.

CONCLUSION
Since the costs of both the alternatives are equal, R Ltd is likely to be indifferent between factoring and bank advance