Benzy limited is a wholesaler that offers its customers a month credit period. The finance director has estimated that annual credit sales for the next accounting period would be ￡1,000,000 and credit customers take 40 days to pay. The company’s bad debts have historically been about 5% of sales. The company finances its trade receivables using bank overdraft, on which interest is charged at 15%. If the factor is not used then the company would need to employ a part-time bookkeeping member of staff who will be paid ￡4,800 per year.
The company has approached a factor which has offered to take over the sales ledger administration and collection of debts at a charge of 3% of the credit sales. This will be a non-recourse factoring service. The factor has guaranteed to reduce the credit days to 30 days and it will provide finance for 80% of the trade receivables at an interest of 5% per annum. The factor has also stipulated in the contract agreement for Benzy limited to take insurance against bad debt and the premium required is 2% of sales revenue per year.
The company estimates that by using the factor, it will save admin costs of ￡3,000 per annum.
i)Calculate and recommend whether or not the company should factor their debts. You should state any assumptions you make. Discuss other factors that should be considered before a final choice is made between the two alternatives.
ii)Describe the following sources of externally generated information and their usefulness in assessing the creditworthiness of the new customers.
a.Trade references
b.Credit reference agency
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