A small widget business has received a contract to supply widgets to several play centers operated in nearby malls by a multi-national auto company. The total dollar volume of the business is $200,00 per year and the payment terms are Net 60 days. The business owners are understandably excited about the new business opportunity. But they are already borrowing money at 6.5% to finance investments needed to grow the business. The new contract will tie up more money in accounts receivable for the new contract, which will require them to increase the size of their loan.

How much money will be tied up on average in accounts receivable for the new contract?

What is the annual interest charge to carry the above balance as part of the business's small business loan?

Suppose the auto company adopts a reverse factoring program in which it sells its accounts payable to a factor (bank) in return for getting payment terms of Net 75 days. Based on the companys excellent credit rating, the factor will pay the small widget business immediately and will only charge a 3% annual rate on the balance. How much will this save the small widget business in annual interest charges?

Are the widget business, auto company and bank all better off under the reverse factoring arrangement?