16.2 Working capital management - Accounts receivable (2) and payable

Question 1

Accounts receivable - Factoring

Answer 1

• Is the sale of debts to a third party (the factor) at a discount in return for prompt cash
• The factor (usually a bank) takes on responsibility of collecting debt for a fee

Question 2

Services offered by the factor: (entity can choose one or both)

Answer 2

• debt collection and administration - recourse or non recourse
• credit insurance

(non recourse factoring is more expense as the factor bears the costs of any irrecoverable debts)

Question 3

Typical factoring arrangement

Answer 3

1) The company sells goods to customer payable in 30 days
2) The company sells the debt to the factor
3) Up to 80% of debt is paid to the company in advance
4) The customer pays the factor after 30 days
5) The factor pays the company the balance less an administration and finance fee

Question 4

Advantages of factoring AR

Answer 4

• Saving in administration costs
• Reduction in need for management control
• Particularly useful for small and fast growing businesses where credit control dep can’t keep up with growth

Question 5

Disadvantages of factoring AR

Answer 5

• Likely to be more costly than an efficiently run internal credit control dep
• Factoring has a bad reputation associated with failing companies
• Customers may not wish to deal with a factor
• Once you start factoring it is difficult to go back to internal credit control system
• The company may give up the opportunity to decide who to give credit to (non recourse factoring)

Question 6

Accounts receivable - Invoice discounting

Answer 6

• is a method of raising finance against the security of receivables without using the sales ledger administration services of a factor
• selected invoices are used as security against which the entity can borrow funds
• this is a temporary source of finance, repayable when the debt is cleared
• similar to financing part of factoring service without control of credit passing to factor

Question 7

The key advantages of invoice discounting

Answer 7

• confidential service, and the customer doesn’t need to know about it
• business retains control over it sales ledger

Question 8

Typical arrangement for invoice discounting

Answer 8

1) The company sells goods to the customer payable in 30 days
2) The company borrows up to 80% of the value of the debt
3) The company receives payment
4) The company pays the invoice discounter the amount borrowed plus interest

Question 9

Accounts payable - managing trade credit

Answer 9

• Trade credit is the simplest and most important source of short term finance for many entities
• Managing trade credit is a balancing act between liquidity (delaying payments to suppliers) and profitability (delaying too long could cause problems)

Question 10

Possible problems of delaying payments to suppliers

Answer 10

• Suppliers may refuse to supply in future
• Suppliers may only supply on a cash basis
• There may be loss of reputation
• Suppliers may increase prices in future

Question 11

Cost of trade credit

Answer 11

• normally seen as free source of finance
• however if the supplier offers a discount for early payment the cost will be the lost discount

Question 12

Age analysis of payables helps keep management aware of

Answer 12

• The total amount payable to suppliers
• When the money will be payable
• The amounts payable to each supplier, and how close to credit limit it is
• Whether the entity is failing to pay its trade suppliers on time