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- 15 Marks
Question
a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.
Required:
Differentiate between factoring and invoice discounting.
(5 marks)
b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.
A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.
The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.
Required:
Advise whether the company should take on the new customers.
(10 marks)
Answer
a) Difference Between Factoring and Invoice Discounting
- Factoring:
- Factoring involves the sale of receivables (invoices) to a third party (the factor) at a discount. The factor takes on the responsibility of collecting payments from customers.
- The factor usually manages the sales ledger and takes over credit control, making it more visible to customers that factoring is being used.
- Invoice Discounting:
- Invoice discounting involves borrowing against the value of receivables without transferring ownership to the financier. The business retains control over the sales ledger and continues to manage customer relationships.
- Invoice discounting is typically confidential, so customers are unaware that their invoices are being used as collateral.
b) Assessment of the New Credit Policy for ATA Ghana Ltd
Current Policy:
| Item | Calculation | Value (GH¢) |
|---|---|---|
| Annual Sales | – | 24,000,000 |
| Contribution Margin | 30% of Sales | 7,200,000 |
| Bad Debts | 1% of Sales x 70% Variable Cost | 168,000 |
| Cost of Debtors | 20% of (1/12 * Sales * 70% Variable Cost) | 280,000 |
| Net Contribution | Contribution – Bad Debts – Cost of Debtors | 6,752,000 |
Proposed Policy:
| Item | Calculation | Value (GH¢) |
|---|---|---|
| Annual Sales | – | 30,000,000 |
| Contribution Margin | 30% of Sales | 9,000,000 |
| Bad Debts | 1.5% of Sales x 70% Variable Cost | 315,000 |
| Cost of Debtors | 20% of (2/12 * Sales * 70% Variable Cost) | 700,000 |
| Net Contribution | Contribution – Bad Debts – Cost of Debtors | 7,985,000 |
Analysis:
| Item | Value (GH¢) |
|---|---|
| Increased Contribution | 1,800,000 |
| Increased Bad Debts | (147,000) |
| Increased Cost of Debtors | (420,000) |
| Net Benefit | 1,233,000 |
Decision:
ATA Ghana Ltd should pursue the policy of taking on the new customers. The net benefit of GH¢1,233,000 justifies the additional risk associated with the longer credit period and higher bad debt percentage.
- Tags: Credit Policy, Factoring, Invoice Discounting, Working Capital
- Level: Level 2
- Topic: Management of receivables and payables, Working Capital Management
- Series: MAY 2017
- Uploader: Joseph