Example1:

Under an advance factoring arrangement Bharat Factors Limited (BFL) has agreed to
advance a sum of Rs.14 lakh against the receivables purchased from ABC Limited. The
factoring agreement provides for an advance payment of 80 percent of the value of factored
receivables and for guaranteed payment after three months from the date of purchasing the
receivables. The advance carries a rate of interest of 16% p.a. compounded quarterly and the
factoring commission is 1.5 percent of the value of factored receivables. Both the interest and
commission are collected upfront.
 Compute the amount actually made available to ABC Limited.
 Calculate the effective cost of funds made available to ABC Limited.
 Assume that the interest is collected in arrear and the commission is collected in
advance. Calculate the effective cost of funds made available to ABC Limited.

Example 2:

Innovative Factors, the subsidiary of Fair Bank offers the following fund-based
Facilities
-
Facility Recourse Non-Recourse
Factoring Factoring
A Discount Charge (payable 19% p.a. 19% p.a.
upfront)
B Reserve 20% 20%
C Commission (payable 1.5% 3.5%
upfront)

The finance manager of Varun Textiles has recently approached Innovative Factors for
factoring the receivables. After a careful analysis of the sales ledger of Varun Textiles, the
Vice President (Operations) of Innovative Factors agrees for a guaranteed payment period of
60 days. The finance manager is not clear about the
type of facility he should opt for and seeks your help in this regard. He provides you with the
following additional information:
1. The firm sells on terms 2/10 net 60. On an average 40% of the customers pay on the tenth
day and avail the discount; the remaining customers pay, on average, 90 days after the
invoice date.
2. The bad debt losses amount to 1.5% of the sales turnover.
3. The sales executives are responsible for following up collections and they, on average,
spend 20% of their time on collection efforts. A subjective (and conservative) assessment is
that the firm can increase its annual sales by Rs.20 lakh if the sales executives are relieved
from collection responsibilities. The gross margin on sales is 20% and the projected sales
turnover for the following year (without considering the increase of Rs.20 lakh) is Rs.240
lakh.
4. By hiving off sales-ledger administration and credit monitoring, the firm can save
administrative overheads to the tune of Rs.1 lakh per annum.
5. As of now, the firm has been financing its investment in receivables through a mix of bank
finance and long-term funds in the ratio of 2:1. The effective rate of interest on bank finance
is 18% p.a. and the cost of long-term funds is around 24% p.a. (pre-tax).

Mini case:
Sunlight industries ltd managers its accounts receivables internally by its sales and credit
department. The cost of sales ledger administration standards at ₹9 cores annually. It supplies
chemicals to heavy industries. These chemicals are used as raw material for further use or are
directly sold to industrial units for consumption. There is good demand for both the types of
uses. For the direct consumers, the company has a credit policy of 2/10, net 30. Past
experience of the company has been that on average 40% of the customers avail of the
discount while the balance of the receivables are collected on average 75 days after the
invoice date. Sunlight industries also has small dealer networks that sell the chemicals. Bad
debts of the company are currently 1.5 % of total sales.
Sunlight industries finances its investments in debtors through a mix of bank credit and own
long term funds in the ratio of 60:40. The current cost of bank credit and long term funds are
12% and 15% respectively.
There has been a consistent rise in the sale of the company due to its proactive measures in
cost reduction and maintaining good relations with dealers and customers. The projected
sales for the next year are ₹800 crore, up 15% from last year. Gross profits have been
maintained at a healthy 22% over the years and are expected to continue in future.
With escalating cost associated with the in-house management of debtors coupled with the
need to unburden the manage with the task so as to focus on sales promotion, the CEO of
sunlight industries is examining the possibility of outsourcing its factoring service for
managing its receivables. He assigns the responsibility to Anitha Guha, the CEO of sunlight.
Two proposals the details of which are given below, are available for Anitha’s consideration.
Proposal from Canbank Factors ltd: the main elements of the proposal are
1. Guaranteed payment within 30 days.
2. Advance, 88% and 84% for the re-course and non-recourse arrangements
respectively
3. Discount charge, with recourse 22% and 21% without recourse
4. Commission 4.5% without recourse 2.5% with recourse; upfront
Proposal from Indbank factors:
1. Guaranteed payment within 30 days
2. Advance, 84% with recourse and 80% without recourse
3. Discount charge upfront, without recourse 21% and with recourse 20%
4. Commission upfront, without recourse 3.6 % and with recourses 1.8 %
The opinion of the chief Marketing manager is that the context of the factoring arrangement,
his staff would be able to exclusively focus on sales promotion which would result in
additional sales of ₹ 75 crores.
The CFO of sunlight industries seeks your advice as a financial consultant on the alternative
proposals. What advice would you give? Why? Calculations can be up to one digit only.