Reference no: EM132790962

In looking to reduce the working capital funding requirement, the financial controller of Zigg Ltd is considering factoring credit sales. The company's annual revenue is €2.5m of which 90% are credit sales. Irrecoverable debts are typically 3% of credit sales.

The offer from the factor is conditional on the following:

(1) The factor will take over the sales ledger of Zigg Ltd completely.

(2) 80% of the value of credit sales will be advanced immediately (as soon as sales are made to the customer) to Zigg Ltd, the remaining 20% will be paid to the company one month later. The factor charges 15% per annum on credit sales for advancing funds in the manner suggested. The factor is normally able to reduce the receivables' collection period to one month.

(3) The factor offers a 'no recourse' facility whereby they take on the responsibility for dealing with irrecoverable debts. The factor is normally able to reduce irrecoverable debts to 2% of credit sales.

(4) A charge for factoring services of 4% of credit sales will be made.

(5) A one-off payment of €25,000 is payable to the factor.

The salary of the part-time sales ledger administrator (€12,500) would be saved under the proposals and overhead costs of the credit control department, amounting to €2,000 per annum, would have to be reallocated. Zigg Ltd.'s cost of overdraft finance is 12% per annum. Zigg Ltd. pays its sales force on a commission only basis. The cost of this is 5% of credit sales and is payable immediately the sales are made. There is no intention to alter this arrangement under the factoring proposals.

Problem 1: Critically evaluate the proposal to factor the sales ledger of Zigg Ltd.