ABC Co. is a registered company in Tanzania selling building materials in large quantities. The
company is having problems in management of its working capital and the company's finance
director has been looking into ways to improve the company's working capital management.
ABC Co. has revenue from credit sales of TZS.1,337,500,000 per year and although its credit
terms require all credit customers to settle outstanding invoices within 40 days, on average
customers have been taking longer. Approximately 1.2% of credit sales turn in to bad debts
which are not recovered. Trade receivable currently stand at TZS.222,900,000 and ABC Co.
has a cost of short-term finance of 5% per year.
The company's finance director is considering a proposal from a factoring company, KG Co.
which was invited to tender to manage the sales ledger of ABC Co. on a with-recourse basis.
KG Co. believes that it can use its expertise to reduce average trade receivables days to 36
days, while cutting bad debts by 75% and reducing administration costs by TZS.2,500,000 per
year. A condition of the factoring agreement is that KG Co. would also advance ABC Co. 80% of
the value of invoices raised at an interest rate of 8% per year. KG Co. would charge an annual
fee of 0.70% of credit sales.
Assume that there are 360 days in each year.
REQUIRED:
Advise whether the KG Co's offer is financially acceptable to ABC Co.