The management of receivables – Simple settlement discount – ACCA Financial Management (FM)
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Dear Sir,
Thank you for the wonderful lecture. Just wanted to check my understanding of the logic and terminology here, for the question in Example 1, is it correct to say that we are comparing between the Compound discount rate over a year (or per annum) and the simple interest rate from overdraft per annum?
Thanks in advance for your feedback.
Regards,
Tim
Not really. We compounded the monthly cost of the discount to get the equivalent annual rate so as to compare with the overdraft annual rate.
(I wouldn’t really worry about the terminology here anyway for Paper FM)
Hi sir, does the effective cost p.a. mean the cost of the discount + interest cost of reduced overdraft together?
No it doesn’t. It is the effective interest cost of offering the discount which we can then compare with the overdraft interest rate.
So if the question asked (in absolute terms) should we offer the discount, we would take the 20% x old receivables VS 27.76% x new receivables?
Mr. Moffat, why did you use TWO months not THREE months since it was THREE months given in the question??????
I’m sorry, I just figured out right now and unfortunately I can’t delete my comment, my apologies….
No problem 馃檪
The period is reduced by 2 months – from 3 months down to 1 month.
Hi Mr Moffat. I hope you are well. in the second example that you showed i entered 1/99 on my calculator but it is giving me 0.01. How do i get the same figure as you got?
Maybe you have set your calculator to round to 2 decimal places, but 1/99 is certainly equal to 0.010101 (and not 0.01).
You are going to have to look at the instruction manual that came with your calculator.
Sir, i don’t understand the comparision without mutiplying the effective cost by time factor.
e.g. 27.75%>20% instead of 1/12* 27.75% < 3/12*20%
We are comparing the equivalent annual % cost of the discount with the annual % cost of the overdraft.
Yes, Sir. But when considering whether to offer the discount, should we take T/R days into account ? The 27.75% is only used for one month while the 20% is used for 3 months.
No – they are both being expressed as yearly costs.
Thank you Sir.
You are welcome 馃檪
Sir, when i caculated the net cost in Example 1, i got two outcomes.
One was (3/12*12*20%-1/12*12*27.75%)-4%*12m= -157,500
The other one was 60/365*12m*20%-4%*12m= -85,479
I wondered which one was correct.
Sir. Why don’t we use like: 4.167%*6 because 4.167% in the example is equal to 2 months? When I multiple like that, it will equally to 12 months . Is there any misunderstanding in here 馃檨
It is compound interest. Check back to the Paper MA (was F2) lectures if you have forgotten.
Yes, Sir. But why we cannot use the formula like in my examples. Is it because normally or in reality, people usually use compound interest instead of using simple interest, right Sir?
It is not a question as to what anyone might do in reality, it is calculating what the true interest cost per year is (which is what matters for the company).
Thank you Sir.
You are welcome 馃檪
Yet again, your explanations switching lightbulbs in my head. Thank you so much, Mr Moffat, for your concise explanations.
Sir, I couldn’t understand the comparison of the Effective % cost with the overdraft interest of 20%. How does that tell us whether we should offer the discount or not?
Getting money early means we can reduce our overdraft and save the overdraft interest. However giving the discount is costing money even though it saves interest.
Okay. got it .Thanks 馃檪
You are welcome 馃檪
For example 2. How did we arrive at 10 days and 25 days. it’s nowhere in the question
Its just his question not there in notes.
For example 2, was 25 days and 10 days assumed. It’s nowhere in the question
Thanks Mr Mofatt for this lecture. Your explanation is always in place.
Hello,
I am a bit confused her with the first example.
From what I know, effective interest rate (R)= [(1+ i/n)^n] -1
My question is why didn’t you divide 0.04167 by 6 in the bracket? Any reason for that?
Here is what i mean
R= [(1+0.04167/6)^6] -1
Why would be divide by 6??
The interest of 4.167% over 2 months. There are 6 periods of 2 months in a year and so if it was not for the fact that the interest was compounded, then the yearly interest would be
6 x 4.167%. Because it is compounded it is as I show in the lecture: (1.04167^6) – 1.
If you are still unsure about compounding then do watch the Paper MA lectures on interest, because this is revision from Paper MA (was F3).
I agree with your approach and it makes sense, (I have watched the lecture from MA).
But why than your formula reveals the different results comparing to usual EAR formula: (R)= [(1+ i/n)^n] -1 ?
This formula is used everywhere, even in Excel by using the internal formula “Effect” for EAR I got 25,44% instead of your’s 27.7559%.
In Excel I used: =(EFFECT(0.04167,6)*6+1)*100 (for mine calculations with EAR formula) and =100*POWER(1.04167,6) – for yours.
thank you
As per my understanding the formula is correct, but 4.167% over two months only not for per annum, therefore there is no need to divide by n as it is not given as annual interest rate.is this make sense?
we added 1 to the yearly rate in example 1 to get 1.04167 thats fine, but in the next question the yearly rate is 1.0101, when we add 1 to it it should be 2.0101 but you didnt add 1, may i ask why
If, for example, the monthly percentage was 1%, then adding on 1% each month is the same as multiplying by 1.01 each month – try it yourself with some made up numbers.
If you are still unsure that watch the Paper MA (was F2) lectures on interest.
Kindly help me to understand where $100 is coming from.
You could use any figure, but because they are %’s it is easiest to use $100. For every $100 that they invoice, $4 is discount.
Use X’s if you prefer!!
Thank you very much.
Why do we add 1 to the percentage while calculating the annual cost