CIMA F1 Syllabus D. Management Of Working Capital And Cash - Debt Factor - Notes ^{6 / 12}

A factor can work in different ways…

It can simply be they take over a company’s credit control department for a fee

It may be that the factor forwards the company some money in advance, and then collects the money from the debtors themselves and keeps the money.

The amount forwarded here would be like a loan and so the factor would also charge interest

Finally, if the factor does “buy” the company’s debts then the deal may be “with recourse” or “without recourse”

1. With Recourse - Any bad debts get returned to the company

2. Without Recourse - Any bad debts are suffered by the Factor

Illustration:

Aveer has sales of $2.5 million and trade receivables of $420,000 which is 60 days worth of sales.

The receivables are financed using a bank overdraft that carries an interest rate of 12%. 

Aveer is considering using a factor to collect in his debts.

The terms of the agreement are:
1) 80% of the receivables value will be received by Aveer with no recourse. 
2) The factor charges a fixed fee of $20,000 plus interest on the amount advanced of 10%. 
3) Aveer expects credit control savings of $40,000 if the agreement is accepted.

Is it appropriate to accept the terms of the factoring agreement?

Solution:

Fixed fee - $20,000

Cost saving - ($40,000)

Interest on factor cash advanced
(2.5m x 80% x 10% x 60/365) = $32,877

Interest on overdraft
(2.5m x 20% x 12% x 60/365) = $9,863

Total cost of factoring agreement
(20,000 - 40,000 + 32,877 + 9,863) = $22,740

Total cost without factoring agreement (overdraft interest)
420,000 x 12% = $50,400

So it is beneficial for Aveer to accept the terms of the factoring agreement.