6 Factoring services. Your friend John owns and operates Craft Catering, a mediumsized catering service business, which has supply contracts with leading airlines, local pubs, and supermarket chains. It supplies 80 per cent of its sales on credit.

The pressures of managing substantial business growth in recent years have resulted in a deterioration in credit management and debtor collection procedures. The average collection period has consequently slipped from 30 days to 70 days, and bad debts have risen to one per cent of credit sales. The business is currently relying on a bank overdraft, at an interest rate of 8 per cent, to finance its debtors.

John has heard about factoring, and is considering contracting out the entire credit management function to the factoring services arm of his local bank. The factor has quoted terms of a prepayment of 75 per cent of the amount invoiced. The balance of 25 per cent, less fees of 1.5 per cent of credit sales, will be paid over to the company when the customer pays the factor. The factor insists all customer accounts will be collected within the normal 30 day credit period, and that bad debts will be eliminated. Financing charges on the monies advanced will be at 9 per cent per year.
Sales for Craft Catering for next year are projected at £8m. The company is currently spending £20,000 per year on administering its sales ledger and credit control systems.
You are required to advise John whether he should accept the factoring arrangement. Assume a 365 day year.