Factoring services

Factoring is selling the debts that your customer owe to you to another party.

A factor purchases book debts from his client. The factor undertakes the responsibility of handling all the clients receivables. The factor receives a duplicate copies of the invoices raised on the customer and client receives advance up to 80% of invoice amount

The factor follows up with the customer depending upon the agreement.

Charges

IPC (Initial payment charges): where the factor charges a discount on the advance amount drawn by the client, a rate equivalent to interest charges of the bank. FC( Factoring commission): For rendering administrative services relating to sales ledge administration, collection of debts and underwriting the credit risk involved i.e. bad debts.

In India SBI launched the SBI Factoring and commercial services Ltd in 1991 on the recommendation of RBI Followed by Canara Bank, Canbank Factoring services ltd.

Types

Notified Factoring Non-notified Factoring With recourse/ without recourse factoring. Full service Non-recourse Full service recourse Undisclosed factoring Bulk agency factoring

Cost of capital

Capital Budgeting Decision/ Investment Decision.

Planning for capital expenditure decision for acquiring a capital asset such as new building, new machinery or new project as a whole.

Features of capital budgeting decision

Replacement Expansion Diversification Other project

Definitions

G.D.Quirin says, a capital investment project may be defined as any project which involves the outlay of cash in return for an anticipated flow of future benefits

Investment of funds today in anticipation of income at a future date R.N.Anthony, any investment involves the commitment of funds now with the expectations of earnings a satisfactory return on these funds over a period of time in future.

F Robert W.Johnson

While the plan to purchase the plant, machinery and equipment becomes a capital budget, the decision making process necessary to develop wise plan is called capital budgeting.

Process of Capital budgeting

Consideration of investment proposals including alternatives. Application of suitable evaluation technique of selecting the project. Estimation of available profits, cash flows and analysis of cost benefit of the project or scheme. Estimation of available funds and utilization thereof

Evaluation methods/ Techniques

Payback period method Average Rate of Return Net present value method

Project evaluation as per payback method

Payback period is defined as the length of time required for the stream of cash proceeds produced by an investment to equal the original cash outlay required by the investment Payback period= Investment/Annual cash inflow.

Eg.

Advantages

It is very simple to measure It emphasizes the liquidity and solvency of a firm For projects involving uncertain returns, it is appropriate to select a measure that concentrates on early returns. It is more useful in case of the firm where risk of obsolesce is high

Eg.

Varying cash patterns Particulars A Investment 24000 Annual cash inflow 1 10000 2 8000 3 6000

B 24000 6000 8000 10000

Disadvantages

It will not be able to differentiate between a project with ten years of life and another with five years of life so long as their payback periods are same. It ignores the present value of cash inflows .

Rate of Return method/Average Rate of Return

It is calculated by dividing the average net profit after tax by the average investment. Avg. rate of return: Net Profit after tax/average investment x100

Average investment

AI would be calculated as original investment + salvage value divided by two. Acceptance Rule: the project which gives highest rate of return over the minimum required rate of return is acceptable.

Limitation

It ignores the time value of money Cash inflows are not taken into consideration. Only net profit after tax is considered.

Net present value method

This method follows the DCF technique and recognizes the time value of money. The method takes into consideration the cash flows (net profit after tax plus depreciation) at the discounted rate. The net present value is found out by subtracting the present value of cash outflow with the present value of inflows. It is defined as the difference between the present value of cash outflow and present value of cash inflow occurring in the future periods over the entire life of the project.

Acceptance Rule

If the NPV is positive or at least equal to Zero, the proposal can be rejected. Among the various alternatives, the project which gives the highest positive NPV should be selected.

Disadvantages

It may not give correct answer when the project with different investments are compared. In such cases, profitability index (PI) method will be better.

Profitability Index

It is a variation of NPV method. It is that ratio of present value of cash inflows to the present value of cash outflow i.e., investment. P.I= P.V of cash inflow/P.V. of cash outflow.

Acceptance rule

To accept the project, PI should be greater than one or at least equal to one. The profitability index of less than one does not indicate loss. In such case the firms cost of capital exceeds the rate of return. Hence, the proposal is to be rejected. NPV gives absolute figures as opposed to profitability index which is a relative measure of profitability.