Pledging Accounts Receivable The Pledging Process Second National Bank of Bryn Mawr is analyzing the accounts receivable

ledger of Crowe Company, an educational publisher, to find acceptable collateral for a pledge or accounts receivable. Each of Crowe's accounts receivable, along with its age and average payment period, is given in Table 15W.2 (below). Because Crowe extends credit terms of 2/10 net 30 EOM, the bank eliminates from further consideration all accounts that are currently overdue (those whose age is greater than 30 days). This immediately eliminates the accounts of customers C, E, and I. The second step in the bank's evaluation process is to analyze the historical payment patterns of the customers. After calculating the average payment period for each customer (given in the last column of Table 15W.2), Second National Bank decides to eliminate customer B, whose account, although not currently overdue, normally requires 60 days to collect. Having eliminated the accounts of customers B, C, E, and I, the bank is left with $45,000 of acceptable accounts from customers A, D, F, G, and H (who owe $10,000, $4,000, $6,000, $14,000, and $11,000, respectively). Crowe Company therefore has $45,000 of acceptable accounts receivable collateral. Each account that is used as collateral is marked in Crowe Company's ledger, and a list of the billing dates and amounts is kept by the bank. TABLE 15W.2: Crowe Company's Accounts Receivable Customer A B C D E F G Account receivable $10,000 8,000 15,000 4,000 3,000 6,000 14,000 Agea 20 days 5 50 14 70 10 3 Average payment period 35 days 60 45 30 60 20 10


11,000 3,000

23 45

10 45

Number of days since the beginning of the credit period.

Adjusting the Dollar Value of Selected Accounts Receivable The $45,000 of acceptable accounts receivable selected by Second National Bank of Bryn Mawr from Crowe Company's books must be adjusted for returns and allowances. The bank decides, after evaluating the company's accounts, that a 5 percent adjustment is appropriate. After this adjustment Crowe Company has acceptable collateral of $42,750 [$45,000 x (1 - .05)]. Applying the Percentage to Be Advanced After a reexamination of Crowe Company's acceptable accounts receivable and general operations, Second National Bank of Bryn Mawr decides to advance 85 percent of the value of the adjusted acceptable collateral. This means that the bank will lend the company about $36,338 (42,750 x .85

Use of Factoring Account Ross Company, a manufacturer of aluminum baseball bats, has sold five accounts to a factor. All the accounts were due September 30. Each account, its amount, and its status on September 30 follow. Account A B C D E Amount $10,000 4,000 50,000 8,000 12,000 Status Collected Sept 20 Collected Sept. 28 Collected Sept. 29 Uncollected Collected Sept. 20

As of September 30, the factor has received payment from suppliers A, B, C, and E. It therefore has already taken its fee, or discount, on each account and remitted the balance to Ross Company. On September 30, the factor has to remit the $8,000 due on account D, less the factoring fee on this account, even though it has not yet been collected. If account D is uncollectable, the factor will have to absorb the loss.

Factoring Cost Graber Company, a producer of children's rainwear, has recently factored a number of accounts. The factor holds an 8 percent reserve, charges on and deducts from the book value of factored accounts a 2 percent factoring commission and charges 1 percent per month interest (12 percent per year) on advances. Graber wishes to obtain an advance on a factored account having a book value of $1,000 and due in 30 days. The proceeds to the company are calculated as follows: Book value of account Less: Reserve (8% x $1,000) Less: Factoring commission (2% x $1,000) Funds available for advance Less: Interest on advance (1% x $900) Proceeds from advance $1,000 80 20 $900 9 $891

The firm receives $891 now and expects eventually to receive the $80 reserve. The exact method that is used to calculate the amount of the advance will vary, depending on the terms of the factoring agreement. Because Graber Company must pay the interest in advance, the effective annual interest cost of this transaction is not 12 percent but 12.12 percent [($9 ÷ $891) x 12]. Of course, if one includes both the factoring commission of $20 and the interest of $9, the annual factoring cost for the transaction would be approximately 39 percent [($29 ÷ $891) x 12].

Floating Inventory Liens
Prescott Toy Company, a manufacturer of inexpensive plastic children's toys, needs a loan of $125,000 for 60 days. The company's primary bank has told management that a loan secured under a floating inventory lien is possible. The annual interest rate would be about 14 percent, which is 5 percent above the prime rate. Funds would be advanced up to 40 percent of the average book value of the secured inventory. This means that the company would have to put up $312,500 in book value of inventory as collateral--the loan required divided by the loan advance ratio ($125,000 ÷ .40). The cost of

this loan is $2,917 ($125,000 x 14% x 2/12). This is equivalent to an effective rate of 2.33 percent for 2 months ($2,917/$125,000) or the stated 14 percent rate annually [2.33% x (12 ÷ 2)] assuming that this is a single transaction.

Warehouse Receipt Loans
GIT Industries, a manufacturer of adhesive products, needs to borrow $80,000 for 1 month to support a seasonal expansion of inventory. The financial manager has approached a commercial finance company about borrowing under a field warehouse receipt arrangement. The terms of the loan are prime plus 3 percent interest per annum, which makes the stated interest rate about 12 percent. Management thinks the prime rate will remain stable during the period of the loan. The finance company will loan 80 percent of the book value of inventory put up as collateral. The loan would require a warehousing charge of $500 per month plus 1 percent of the value of the inventory warehoused. To be able to borrow $80,000, GIT Industries must provide collateral of $100,000--the amount needed ($80,000) divided by the loan ratio (0.80). The cost of the field warehouse receipt loan for 1 month is determined as follows: Field warehouse charge 1% of collateralized inventory charge Loan interest (12%/12 x $80,000) Total cost $ 500 1,000 800 $2,300

The effective interest rate on this loan is 2.875 percent ($2,300 ÷ 80,000) for 1 month. The effective annual cost of the loan is 34.5 percent (2.875% x 12) assuming that this is a single transaction.

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