Tag (SQ): Debt Management

Nsawkaw Tech Solutions Limited is a software business owned and managed by computer software specialists. Although sales have remained stable at GH¢40,000,000 per annum in recent years, the level of trade receivables has increased significantly. A recent financial report submitted to the owners indicates an average settlement period of 60 days for trade receivables compared with an industry average of 40 days. The level of bad debts has also increased in recent years, and the company now writes off approximately GH¢40,000 in bad debts each year.
The recent problems experienced in controlling credit have led to a liquidity crisis for the company. At present, the company finances its trade receivables by a bank overdraft at an interest rate of 14% a year. However, the overdraft limit has been exceeded on several occasions in recent months, and the bank is now demanding a significant decrease in the size of the overdraft.
To meet this demand, the owners of the company have approached a factor who has offered to make an advance payment equivalent to 85% of trade receivables, based on the assumption that the level of receivables will be in line with the industry average.
The factor will charge a rate of interest of 12% a year for this advance. The factor will take over the sales records of the company and, for this service, will charge a fee based on 2% of sales. The company believes that the services offered by the factor should eliminate bad debts and lead to administrative cost savings of GH¢52,000 per year.

Required
(a) Calculate the effect of employing a debt factor on the profit of Nsawkaw Tech Solutions Limited. Comment on your findings.

Note: You may assume 360 days in a year.

(b) State FIVE potential advantages and TWO disadvantages of using the services of a debt factor by a business organisation.