Pledging Accounts Receivable the Pledging Process Second

8/14/2019 Pledging Accounts Receivable the Pledging Process Second

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Pledging Accounts Receivable

The Pledging Process

Second National Bank of Bryn Mawr is analyzing the accounts receivable

ledger of Crowe Company, an educational publisher, to find acceptable

collateral for a pledge or accounts receivable. Each of Crowe's accounts

receivable, along with its age and average payment period, is given in Table

15W.2 (below). Because Crowe extends credit terms of 2/10 net 30 EOM, the

bank eliminates from further consideration all accounts that are currently

overdue (those whose age is greater than 30 days). This immediately

eliminates the accounts of customers C, E, and I.

The second step in the bank's evaluation process is to analyze the historicalpayment patterns of the customers. After calculating the average payment

period for each customer (given in the last column of Table 15W.2), Second

National Bank decides to eliminate customer B, whose account, although not

currently overdue, normally requires 60 days to collect. Having eliminated

the accounts of customers B, C, E, and I, the bank is left with $45,000 of

acceptable accounts from customers A, D, F, G, and H (who owe $10,000,

$4,000, $6,000, $14,000, and $11,000, respectively). Crowe Company

therefore has $45,000 of acceptable accounts receivable collateral. Each

account that is used as collateral is marked in Crowe Company's ledger, and

a list of the billing dates and amounts is kept by the bank.

TABLE 15W.2: Crowe Company's Accounts Receivable

CustomerAccount

receivableAgea

Average payment

period

A $10,000 20 days 35 daysB 8,000 5 60

C 15,000 50 45

D 4,000 14 30

E 3,000 70 60

F 6,000 10 20

G 14,000 3 10


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Factoring

Use of Factoring Account

Ross Company, a manufacturer of aluminum baseball bats, has sold five

accounts to a factor. All the accounts were due September 30. Each account,

its amount, and its status on September 30 follow.

Account Amount Status

A $10,000Collected Sept

20

B 4,000Collected Sept.

28

C 50,000

Collected Sept.

29

D 8,000 Uncollected

E 12,000Collected Sept.

20

As of September 30, the factor has received payment from suppliers A, B, C,

and E. It therefore has already taken its fee, or discount, on each account

and remitted the balance to Ross Company. On September 30, the factor has

to remit the $8,000 due on account D, less the factoring fee on this account,even though it has not yet been collected. If account D is uncollectable, the

factor will have to absorb the loss.


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Factoring Cost

Graber Company, a producer of children's rainwear, has recently factored a

number of accounts. The factor holds an 8 percent reserve, charges on and

deducts from the book value of factored accounts a 2 percent factoring

commission and charges 1 percent per month interest (12 percent per year)

on advances. Graber wishes to obtain an advance on a factored account

having a book value of $1,000 and due in 30 days. The proceeds to the

company are calculated as follows:

Book value of account $1,000

Less: Reserve (8% x $1,000) 80

Less: Factoring commission (2% x$1,000)

20

Funds available for advance $900

Less: Interest on advance (1% x$900)

9

Proceeds from advance $891

The firm receives $891 now and expects eventually to receive the $80

reserve. The exact method that is used to calculate the amount of the

advance will vary, depending on the terms of the factoring agreement.

Because Graber Company must pay the interest in advance, the effective

annual interest costof this transaction is not 12 percent but 12.12 percent

[($9 $891) x 12]. Of course, if one includes both the factoring commission

of $20 and the interest of $9, the annual factoring costfor the transaction

would be approximately 39 percent [($29 $891) x 12].

Floating Inventory Liens

Prescott Toy Company, a manufacturer of inexpensive plastic children's toys,needs a loan of $125,000 for 60 days. The company's primary bank has toldmanagement that a loan secured under a floating inventory lien is possible.The annual interest rate would be about 14 percent, which is 5 percentabove the prime rate. Funds would be advanced up to 40 percent of theaverage book value of the secured inventory. This means that the companywould have to put up $312,500 in book value of inventory as collateral--theloan required divided by the loan advance ratio ($125,000 .40). The cost of


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this loan is $2,917 ($125,000 x 14% x 2/12). This is equivalent to an effectiverate of 2.33 percent for 2 months ($2,917/$125,000) or the stated 14percent rate annually [2.33% x (12 2)] assuming that this is a singletransaction.

Warehouse Receipt Loans

GIT Industries, a manufacturer of adhesive products, needs to borrow

$80,000 for 1 month to support a seasonal expansion of inventory. The

financial manager has approached a commercial finance company about

borrowing under a field warehouse receipt arrangement. The terms of the

loan are prime plus 3 percent interest per annum, which makes the stated

interest rate about 12 percent. Management thinks the prime rate will

remain stable during the period of the loan. The finance company will loan

80 percent of the book value of inventory put up as collateral. The loan

would require a warehousing charge of $500 per month plus 1 percent of the

value of the inventory warehoused.

To be able to borrow $80,000, GIT Industries must provide collateral of

$100,000--the amount needed ($80,000) divided by the loan ratio (0.80).

The cost of the field warehouse receipt loan for 1 month is determined as

follows:

Field warehouse charge $ 500

1% of collateralized inventory

charge1,000

Loan interest (12%/12 x

$80,000)800

Total cost $2,300

The effective interest rate on this loan is 2.875 percent ($2,300 80,000) for1 month. The effective annual cost of the loan is 34.5 percent (2.875% x 12)

assuming that this is a single transaction.

Pledging Accounts Receivable the Pledging Process Second

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