The annual sales of ABC Ltd. are ₹60 lakhs of which 20% is on cash and balance on credit. Debtors are allowed one month to clear off the dues. A factor is willing to advance 90% of the book debts for a fee of 1% per mont

1. Computation of amount financed (Amount ₹) Annual Sales = ₹60 lakh Cash sales 20% (₹12 lakh), credit sales 80% = ₹48 lakh Credit sales per month = 48/12 = ₹4 lakh Finance available in both the situation 90% of credit sales = ₹3.60 lakh (per month) 2. Factoring Cost Fees payable to the factor = ₹3.60 lakh x 1% = ₹3,600 Processing charges = 4% on monthly debtors = ₹4 lacs x 4% = ₹16,000 Total cost = ₹16,000 + ₹3,600 = ₹19,600 Less: Savings in debt management costs = ₹21600 per year or 21600/12 = ₹1,800 per month Savings in book debts = 1% of total debtors = ₹4 lakh x 1% = ₹4,000 Hence, Net factoring cost = ₹19,600 - (₹1,800 + ₹4,000) = ₹13,800 3. Cost of Bank borrowing (working capital against book debts) Limit sanctioned = 90% of book debts = 90% x ₹4,00,000 = ₹3,60,000 Interest payable @ 12% = ₹3,60,000 x 12% = ₹43,200 Per month interest payable = 43,200/12 = ₹3,600 Processing fee = 2% x ₹4,00,000 = ₹8,000 Total cost of bank finance = ₹3,600 + ₹8,000 = ₹11,600 Advice: Since cost of Bank finance is less than that of cost of factoring, company can opt for bank funding.