# Explain how to compare Costs of factoring Accounts receivables with the costs on bank loan

Part 1 describe the features of factoring, its advantages and disadvantages and illustration on how to compute the maximum loan or advance a firm can get from the factoring company.

In this Part 2, we see a simple illustration comparing the cost of factoring against bank offer.

 Illustration : Accept Factoring Or Accept Bank Offers Question: Company XYZ has a yearly sales turnover of \$60 million of which 80% is on credit. Debtors are allowed one month to settle the debt. A factor is willing to advance 90% of the bills raised on credit for a fee of 2% a month plus a commission of 4% on the total amount of debts. Company XYZ as a result of this arrangement is likely to save \$24,000 annually in management costs and avoid bad debts at 1% on the credit sales. A bank has also approached the company to lend an advance equal to 90% of the debts at an interest rate of 18% per annum. However, its processing fee will be at 2% on the receivables. Which sources of financing should Company XYZ choose? Suggested solution: Cost of factoring: (a) Fee of 2% on 90% of \$4,000,000 \$72,000 (80% x 60m=48m/12 =\$4m(monthly sale) (b) Commission of 4% on \$4,000,000 \$160,000 Less: (a) Savings if decision to factor(24,000/12) (\$2,000) (b) Savings from bad debts(1% x\$4,000,000) (\$40,000) NET COST in Factoring \$190,000 Cost of Bank borrowing: (a) Interest at 18% per annum for one month on 90% of \$4,000,000 \$54,000 (b) Processing fee 2% x \$4,000,000 \$80,000 © Bad debts cannot be avoided \$40,000 NET COST using bank borrowings \$174,000 Since the cost of using bank borrowing is cheaper than the company should use this instead of factoring.

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