A factoring company has offered a one-year agreement with Glub Ltd to both manage its debtors and advanced 80 per cent of the value of all its invoices immediately a sale is invoiced. Existing invoices will be eligible for an immediate 80 per cent cash payment.
The annual sales on credit of Glub are Rs6M spread evenly through the year and the average delay in payment from the invoice date is at present 80 days. The factoring company is confident of reducing this delay to only 60 days and will pay the remaining 20 per cent of invoice value to Glub immediately on receipt from the customer.
The charge for debtor management will be 1.7 per cent of annual credit turnover payable at the year-end. For advance payment on he invoices a commission of 1 per cent will be charged plus interest applied at 10 per cent per annum on the gross funds advanced.
Glub will be able to save Rs80, 000 during this year in administration costs if the factoring company takes on the debtor management. At the moment it finances its trade credit through an overdraft facility with an interest rate of 11 per cent.
Required
Advise Glub on whether to enter into the agreement. Discuss the relative advantages and disadvantages of overdraft, factoring and term loan financing.