A scheduled bank has come forward to make an advance equal to 90% of the debts at an interest rate of 18% p.a. However its processing fee will be at 2% on the debts. Would you accept factoring or the offer from the bank? Solution: Factoring vs. Bill Discounting: Alternative 1: Factoring: Calculation of Effective Cost of Factoring: Sale for the year 6000000 Credit sales 4800000 Receivables = (4800000 / 12) x 1 month 400000 7200 Cost of factoring: (Per month) Fee interest) 400000 x 90 % x 2% Commission 400000 x 4% Cost per month 16000 23200 Savings: Management cost (21600/12) Bad debts (400000 x 1%) (1800) (4000) 17400 Alternative 2: Bill Discounting: Cost of Bill Discounting U43 Average debtors - 400000p.m Processing Fee (400000 x 2 %) 8,000 Interest / Discount (400000@90% x 18% x (1 /12)] 5,400 Loss due to bad debts p.m 4000 Administration cost 1800 19200 Company may Opt Factoring but not Bill discounting. Illustration 6 Star Limited manufacturers of Colour TV Sets, are considering the liberalization of existing credit terms to three of their large customers A, B and C. the credit period and likely quantity of TV sets that will be lifted by the customers are as follows: Credit period (Days) B 0 1,000 1.000 1,000 1,000 1,500 30 60 2.000 1,000 90 1,000 2,500 1,500 The selling price per TV set is Rs. 9,000. The expected contribution is 20% of the selling price. The cost of carting debtors averages 20% per annum. You are required: (a) Determine the credit period to be allowed to each customer. (Assume 360 days in a year for calculation purposes). (b) What other problems the company might face in allowing the credit period as determined in (a) above