Page 270 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes

Task ABC Company’s existing sales are 180 lakhs. It is currently extending a credit
period of ‘net 30 days’ to its customers. The company’s contribution to sales ratio is 20 per
cent and the cost of funds is 15 per cent. The company is contemplating to increase its sales
by 16 lakhs to be achieved by means of lengthening the existing period to ‘net 45 days’.
The bad debt losses on additional sales is expected to be 5 per cent. Should the company go
in for a policy change or not.
Self Assessment

Fill in the blanks:
5. The …………………represents the basic criteria for the extension of credit to customers.
6. Efficient and timely collection of debtors ensures that ……………losses are reduced to the
minimum and the average collection period is shorter.
7. Credit terms have three components which are………………; Cash discount and Cash
discount period.
8. If the demand for the products is elastic, reduction in prices will result in ……….....sales
volume.

12.3 Factoring and Credit Control

A large firm has some advantages, in managing its accounts receivable. First, it may be possible
for divisions to pool information on the creditworthiness of its customers. Second, there are
potential companies of scale in record keeping, billing, etc., especially if the process can be
computerized. Third, debt collection is a specialized business that calls for experience and
judgement. The small firm may not be able to hire or train a specialized credit manager. However,
it may be able to obtain some of the economies by parking part of the job out to a factor and the
arrangement is known as factoring.

Factoring is a collection and finance service designed to improve the cash flow position of the
sellers by converting sales invoices into ready cash. It is a continuing arrangement between the
factor and the seller client, the factor purchases the client’s debtors and in relation thereto
controls the credit extended to the customers and administer the sales ledger.

1. Under an agreement between the seller and selling firm, the latter makes an appraisal of
the creditworthiness of the potential customers and may also set the credit limit and terms
of credit for different customers.

2. The sales documents will contain the instructions to make the payment directly to the
factory that is responsible for the collection.
3. When the payment is received by the factor on the date, the factor shall deduct its fees,
charges, etc., (as agreed) and credit the balance to the firm’s accounts.
4. In some cases, if agreed, the factor firm may also provide advance finance to the selling
firm for which it may charge from the selling firm. In a way, this tantamount to bill
discounting by the factor firm. However, factoring is something more than mere bill
discounting, as the former includes analysis of the credit worthiness of the customer too.
The factor may pay whole or a substantial portion of the sales value to the selling firm
immediately on sales being affected. The balance, if any, may be paid on the normal due
date. The mechanism of factoring has been presented in following figure:

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