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Dear Sir, I watched the lecture on RECEIVABLES / PAYABLES, it was great and I really appreciate the way you explain things with a reasonable pace so that we can understand and follow. Just one question: I have seen a comment for example 5 (page 27) where Priyanka asked why an effective cost being more than overdraft can be beneficial.
I also read your reply where you state that “Delaying payment would save us overdraft interest, but would lose us the discount.” which I completely agree, but I fail to understand the logic of effective cost. It is a cost after all (whether in % or not) for me 24% is much higher than 13% and they BOTH represent a cost to the company so why would a 24% effective cost be more beneficial than a 13% cost (as overdraft)?
If we pay early, then the discount is not a cost – it is a saving! By paying early we pay less and effectively save 25%. However, paying early will increase our overdraft and that will cost us 13%.
Since the saving is great than the cost it is better to take the discount and pay early.(If you prefer, then look at it the other way round. If we delay payment then we lose the discount and pay more – that costs us 25%. But by delaying we have a lower overdraft and therefore save overdraft interest at 13%. It is not worthwhile paying 25% and only saving 13% and therefore we should not delay – we should take the discount.)
Thank u sir so if we want to conclude, it goes like this:
RECEIVABLE – Discount given is eventually a COST for the company X (from X’s perspective), so the ANNUAL EFFECTIVE RATE is actually a cost and if % is higher than % overdraft, then it’s NOT worthwhile.
PAYABLE – Discount taken is eventually a SAVING for the company X (again from X’s perspective), so the ANNUAL EFFECTIVE RATE is actually a SAVING and if % is higher than % overdraft, then it IS worthwhile.
is that correct?
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