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Kim Smith.
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Noah098
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“The company’s finance costs as a percentage of long?term borrowings have increased from 5.6% in 20X4 to 13.4% in 20X5. This may be due at least in part to the interest on the overdraft proving to be an expensive way of financing the entity’s operations and if the overdraft has not been agreed with the bank, the company may be incurring additional penalties and charges thereby putting additional strain on the company’s cash flows.”
maam without agreement of the bank the company cannot even avail itself overdraft facilities, so then why does the above paragrpah state that “if the overdraft has not been agreed with the bank, the company may be incurring additional penalties and charges thereby putting additional strain on the company’s cash flows.”?
Kim Smith
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A bank may allow a client to “go into ‘the red'” (meaning into an overdraft position) or exceed a current overdraft facility without prior agreement – rather than “bounce” payments – but with punitive charges (i.e. with extremely high charges acting as a deterrent).
Noah098
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oh so if a company seeks an approval from bank prior to using their OD facilities, then they will be charged lesser amount of charges compared to when they do it directly without seeking any permission, is that so?
So if a company does want an affordable rate it will have to seek permission, which makes me wonder why would companies then not go for a new loan rather than seek a OD facility? Is it that post-permission seeking OD rate will be cheaper than going for a new loan?
Kim Smith
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Yes to your first paragraph.
The strategic professional level exams assumes some knowledge of the workings of “finance” – if not from practical experience, then from FM(F9).
If you’ve never had an overdraft – perhaps you have a credit card? The credit card company gives you a credit limit. It doesn’t cost you anything to use a credit card if you pay the balance owed, in full, at the end of the month – you only pay interest – perhaps at 24% APR (!!!) – to the extent that you use the credit limit. Unlike a bank overdraft, it is not possible to exceed the credit limit (because any payment that would take you over the limit will be “declined” at the point of sale).
If a company takes out a $100,000 loan – that is a fixed amount – and it will pay interest every day on the loan amount. An overdraft is a FACILITY – interest is only paid to the extent that it is used. You should remember from FM that if a company’s use of an overdraft is “of a permanent nature” then you are quite right – it should be re-negotiated as a loan.
Noah098
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