The finance Director of your company is concerned about the lax management of the company’s trade receivables. The trade terms of the company require settlement within 30 days, but its customers take an average of 60 days to pay their bills. In addition, out of total credit sales of K20million per year, the company suffers bad debts of K200,000 per year. The company finances working capital needs with an overdraft at a rate of 8% per year. You have been asked to review the following options. Option 1: Offering a discount of 1% for payment within 30 days. It is expected that 35% of customers will take the discount, while the average time taken to pay by the remaining customers will remain unchanged. As a result of the policy change, bad debts would fall by K60,000 per year and administration costs by K20,000 per year Option 2: The debt administration and credit control of the company could be taken over by a factoring company. The annual fee charged by the factor would be 1.75% of sales. The company would gain administration cost savings of K160,000 per year and an 80% reduction in bad debts. The factor would reduce the average trade receivables days of the company to 30 days and would advance 80% of invoices at an interest rate of 12% Required Calculate the benefits, if any, to the company of the two suggested options

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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The finance Director of your company is concerned about the lax management of the company’s trade receivables. The trade terms of the company require settlement within 30 days, but its customers take an average of 60 days to pay their bills. In addition, out of total credit sales of K20million per year, the company suffers bad debts of K200,000 per year. The company finances working capital needs with an overdraft at a rate of 8% per year. You have been asked to review the following options.

Option 1: Offering a discount of 1% for payment within 30 days. It is expected that 35% of customers will take the discount, while the average time taken to pay by the remaining customers will remain unchanged. As a result of the policy change, bad debts would fall by K60,000 per year and administration costs by K20,000 per year

Option 2: The debt administration and credit control of the company could be taken over by a factoring company. The annual fee charged by the factor would be 1.75% of sales. The company would gain administration cost savings of K160,000 per year and an 80% reduction in bad debts. The factor would reduce the average trade receivables days of the company to 30 days and would advance 80% of invoices at an interest rate of 12%

Required

Calculate the benefits, if any, to the company of the two suggested options

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