Financial Decision making Using Cost-benefit analysis
Published on Jun 13, 2020
Oscar Co designs and produces tracking devices. The company
is managed by its four founders, who lack business administration skills.
The company has revenue of $28m,
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. Oscar Co is a rapidly growing company and revenue has doubled in the
last four years. Oscar Co has focused in this time on product development and
customer service, and managing trade receivables has been neglected.
Oscar Co’s average trade
receivables are currently $5·37m, 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, Oscar Co has approached a factoring
The factoring company has offered
two possible options:
Option 1: Administration by
the factor of Oscar Co’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. Oscar Co estimates that this would
result in savings of $30,000 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 Oscar Co’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. Oscar Co would be
required to accept an advance of 80% of credit sales when invoices are raised
at an interest rate of 9% per year.
Oscar Co pays interest on its
overdraft at a rate of 7% per year and the company operates for 365 days per
the costs and benefits of each of Option 1 and Option 2 and comment on your
reasons (other than costs and benefits already calculated) why Oscar Co may
benefit from the services offered by the factoring company.
THREE factors which determine the level of a company’s investment in working
Ref: Specimen paper ACCA