Page 180 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 11: Factoring

proceeds to bolster its own growth than it would be by effectively functioning as its “customer’s Notes
bank.” Accordingly, factoring occurs when the rate of return on the proceeds invested in
production exceed the costs associated with factoring the receivables. Therefore, the trade off
between the return the firm earns on investment in production and the cost of utilizing a factor
is crucial in determining both the extent factoring is used and the quantity of cash the firm holds
on hand.
Many businesses have cash flow that varies. A business might have a relatively large cash flow
in one period, and might have a relatively small cash flow in another period. Because of this,
firms find it necessary to both maintain a cash balance on hand, and to use such methods as
Factoring, in order to enable them to cover their short-term cash needs in those periods in which
these needs exceed the cash flow. Each business must then decide how much it wants to depend
on factoring to cover short falls in cash, and how large a cash balance it wants to maintain in
order to ensure it has enough cash on hand during periods of low cash flow.

Generally, the variability in the cash flow will determine the size of the cash balance a business
will tend to hold as well as the extent it may have to depend on such financial mechanisms as
factoring.

Case Study Yahoo. Products Limited

ahoo. Products Limited manufactures a special variety of industrial which are
used by other manufacturing units to produce shoes and chappals. The market for
Ythe company’s product comprises a few large public limited companies and a
number of small units run as proprietary or partnership concerns. The sales had in the past
proved to be seasonal, with peak sales being recorded in the period January to July (year).
One year back, the company had expanded its production capacity form 4,000 to 9,000 MT
per annum. However, the actual production in the financial year just ended was restricted
to 6,000 MT, mainly on account of lack of orders. The cost statement for the year indicated
the following:
`/MT
Raw Materials (V) 2,500
Direct Labour and Supervision (F) 800
Indirect Materials, Fuel, etc. (F) 500
Depreciation, Insurance, etc. (F) 2,700
Factory Cost of Production 6,500
Administration, Selling and Interest Charges (F) 500
Selling Price per MT 7,000
(exclusive of all discounts, allowance for freight, etc.) ------

Dr. Bhatt the Director was not satisfied by the under utilization of installed capacity and its
effect on the profitability of the company. He called his senior managers to discuss the
situation and means of improving the profitability of the concern. The Sales Manager, on
whom the pressure was tried to described the limitation of sales to be the stringent credit
policy pursued by the company. He argued that under the strict norms for grant of credit
followed by the company, only the larger public limited companies among the customers
were on the approved credit list of the company and the smaller customers were put on
the cash and carry list. This, he maintained, led to overdependence on the larger customers
and an almost complete neglect of a section of the market consisting of the small
Contd...

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