Factoring

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FACTORING
Sunlight industries Ltd manages its accounts receivables internally by its sales and credit department. The cost of sales ledger administration stands at ` crore 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 per cent 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 have small dealer networks that sell the chemicals. Bad debtors of the company are currently 1.5 per cent of total sales.

Sunlight industries finances its investment 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 per cent and 15 per cent respectively.

There has been a consistent rise in the sales 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 per cent from last year. Gross profits have been maintained at a healthy 22 per cent over the years and are expected to continue in future.

With escalating cost with the in-house management of debtors coupled with the need to unburden the management 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 Anita Guha, the CFO of Sunlight. Two proposals, the details of which are given below, are available for Anita’s consideration.

Proposal from Canbank Factors Ltd: The main elements of the proposal are: 1) Guaranteed payment within 30 days. 2) Advance, 88 per cent and 84 per cent for the resource and non-recourse arrangements respectively.

3) Discount charge in advance, 21 per cent for with recourse and 22 per cent without recourse. 4) Commission, 4.5 per cent without recourse and 2.5 per cent with recourse.

Proposal from Indbank Factors: 1) 2) 3) 4) Guaranteed payment within 30 day. Advance, 84 per cent with recourse and 80 per cent without recourse. Discount charge upfront, without recourse 21 per cent and with recourse, 20 per cent and Commission upfront, without recourse 3.6 per cent and with recourse 1.8 per cent.

The opinion of the Chief Marketing Manager is that in 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 crore. Require: 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 upto one digit only.

SOLUTION.

Financial analysis of receivables management alternatives (rs in crore.)

(A) In-House Management: Cash discount (Rs 800 crore * 0.40 * 0.02) Bad debts (Rs 800 crore * 0.015) Opportunity cost (foregone contribution on lost sales) [Rs 75 crore * 0.205 net of bad debts] Avoidable administrative and selling expenses Cost of investment in receivable ++ Total ++ average collection period (04 * 10 days) + (060 * 75 days) = 49 days Investment in debtors = Rs 800 crore * 49 /360 = Rs 108.9 crore Cost of investment in debtors: (Rs 108.9 * 0.60 *.12) + (Rs 108.9 * .40 * 0.15) = Rs 14.4 crore 6.4 12.0 15.4 9.0 14.4 57.2

(B) Canbank Factors Proposal: With recourse Factoring commission (Rs 875 Crore * 0.025) (Rs 875 crore * 0.045) Discount charge (Rs 750.7 +crore * 0.21 * 30/360) (Rs 701.9++ * 0.22 * 30/360) Cost of long-term funds invested in debtors: [(Rs 875 crore – Rs 750.7 crore) *0.15 *30/360)] [(Rs 875 – Rs 701.9 crore) * 0.15 * 30/360)] 21.9 Nil 13.1 Nil 1.6 Nil 36.6 Without recourse Nil 39.4 Nil 12.9 Nil 2.2 54.5

+ Amt of advance = 0.88 * (Rs 875 cr – Rs 21.9 Cr.) = Rs 750.7 Cr. ++ amt of advance = 0.84 * (Rs 875 Cr. – Rs 39.4 Cr.) = Rs 701.9 Cr.

(C) Indbank Factors Proposal; With recourse Factoring commission (Rs 875 Crore * 0.018) (Rs 875 crore * 0.036) Discount charge (Rs 721.8 +crore * 0.20 * 30/360) (Rs 674.8++ * 0.21 * 30/360) Cost of long-term funds invested in debtors: [(Rs 875 crore – Rs 721.8 crore) * 0.15 *30/360)] [(Rs 875 – Rs 674.8 crore) * 0.15 * 30/360)] 15.7 Nil 12.0 Nil 1.9 Nil 29.6 Without recourse Nil 31.5 Nil 11.8 Nil 2.5 45.8

+ Amt of advance = 0.84 * (Rs 875 cr – Rs 15.7 Cr.) = Rs 721.8 Cr. ++ amt of advance = 0.80 * (Rs 875 Cr. – Rs 31.5 Cr.) = Rs 674.8 Cr.

Decision analysis: Recource Factoring Particulars Bnefits (Rs 57.2 – Rs 12 Bad debts to be borne by company) Costs Net benefits Decision analysis: Non -Recource Factoring Particulars Bnefits (Rs 57.2 – Rs 1.1 Bad debts to be borne by factor) Costs Net benefits

(Rs Crore) Canbank 45.2 36.6 8.6 Indbank 45.2 29.6 15.6

(Rs Crore) Canbank 58.3 54.5 3.8 Indbank 58.3 45.8 12.5

Advice: My advice to the CFO of Sunlight industries would be to aacept the proposal of Indbank Factors for recourse factoring.

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