R BERHAD designs and produces tracking devices

Subject:AccountingPrice: Bought3

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R BERHAD designs and produces tracking devices. The company is managed by its four founders, who lack business administration skills. The company has revenue of RM28m, and all sales are on 30 days' credit. Its major customers are large multinational car manufacturing companies and are often late in paying their invoices. R BERHAD is a rapidly growing company and revenue has doubled in the last four years. R BERHAD has focused in this time on product development and customer service, and managing trade receivables has been neglected. 

R BERHAD's average trade receivables are currently RM5·37m, and bad debts are 2% of credit sales revenue. Partly as a result of poor credit control, the company has suffered a shortage of cash and has recently reached its overdraft limit. The four founders have spent large amounts of time chasing customers for payment. In an attempt to improve trade receivables management, R BERHAD has approached a factoring company. 
The factoring company has offered two possible options: 

Option 1 

Administration by the factor of R BERHAD's invoicing, sales accounting and receivables collection, on a full recourse basis. The factor would charge a service fee of 0·5% of credit sales revenue per year. R BERHAD estimates that this would result in savings of RM30,000 per year in administration costs. Under this arrangement, the average trade receivables collection period would be 30 days. 

Option 2 

Administration by the factor of R BERHAD's invoicing, sales accounting and receivables collection on a non-recourse basis. The factor would charge a service fee of 1·5% of credit sales revenue per year. Administration cost savings and average trade receivables collection period would be as Option 1. R BERHAD would be required to accept an advance of 80% of credit sales when invoices are raised at an interest rate of 9% per year. 

R BERHAD pays interest on its overdraft at a rate of 7% per year and the company operates for 365 days per year.

 

Requirement:

Calculate the costs and benefits of each of Option 1 and Option 2 and comment on your findings.