Question 11.I.20: The Reliable Industries Ltd (RIL) is presently managing its ......

The Reliable Industries Ltd (RIL) is presently managing its accounts receivables internally, through its sales and credit department. Its credit terms for sales are 2/10, net 30. The past experience of the RIL has been that on an average 30 per cent of the customers avail of the discount, while the balance of the receivables is collected, on an average, 60 days after the invoice date. Further, 2 per cent of the sales turnover results into bad debts.
\,  The firm is financing its investments in receivables through a mix of bank finance and long-term finance in the ratio of 2: 1. The effective rate of interest on bank finance is 22 per cent and the cost of own funds is 30 per cent.
\,  The projected sales for the next year is Rs 500 lakh. The credit and collection department spends, on an average, one-fourth of its time on collection of receivables.
\,  A proposal to avail of factoring services from Fairgrowth Factors Ltd (FFL), as an alternative to in-house management of receivables collection and credit monitoring, is under the consideration of the Board of Directors of the RIL. If the proposal, details of which are given below, is accepted, the projected sales for the next year can increase by Rs 50 lakh as a result of the diversion of the time and effort, of the executives of the sales, credit and collection departments, to sales promotion. For the type of product that RIL is producing, the gross margin on sales in the past has been 20 per cent. Moreover, there would be a saving of Rs 2.5 lakh in administrative overheads due to the discontinuance of sales ledger administration and credit monitoring.
\,  According to the factoring proposal, the FFL offers guaranteed payment within 30 days. The other details are listed below:
\,  The FFL would advance 80 per cent and 85 per cent, in case of recourse and non-recourse factoring deals, respectively; the balance would be retained as factor reserves. The discount charge, in advance (up front), would be 22 per cent for recourse type and 21 per cent for non-recourse type of service. The FFL would also charge a commission @ 2 per cent (recourse) and 4 per cent non-recourse. The commission is payable up front.
\,  Before taking a decision on the proposal, the Board seeks your advice, as a financial consultant, on the right of action. What advice would you give? Why?