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John Moffat.
John Moffat.-
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Faizahmad1009
- Topics: 33
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I am having trouble understanding the use of overdraft in the management of payables. Could you please correct the following statements of mine?
1) In payables, is it true that we take overdraft because we have cash storage for running the business that is why we need to borrow money from the bank & have to pay interest (in this case I guess we have to pay monthly interest or yearly as usual)
BUT I don’t get the effect of increase & decrease of overdraft interest cost by the increase & decrease of payables (please explain why decrease in payables results in increase in overdraft cost and vice versa?)
2) In payables, we take overdraft but since we want to delay payments as much as possible to have enough cash to run our business operations & therefore we only take a little amount of overdraft from the bank (because increase in payables means reduction in overdraft cost)
John Moffat
- Topics: 57
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In exam question there is usually an overdraft and therefore if the overdraft increases there is more interest payable. However even if there wasn’t an overdraft but the company had cash in the bank (that would earn interest) then less cash in the bank would mean less interest received and have the same effect.
If we pay our payables sooner (and therefore a decrease in the payables balance) then we need cash sooner which will mean that the overdraft will increase and there will therefore be more interest payable. If we delay paying (and therefore the payables balance is higher) then we do not need cash sooner so the overdraft will be lower and there will be less interest cost.
Faizahmad1009
- Topics: 33
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It may be a silly question to ask but I want to ask anyway that we receive or pay overdraft interest on a monthly basis (Is that correct?) If we are one month late to pay the overdraft interest we will be charged a penalty fee with the due interest.
John Moffat
- Topics: 57
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If there is an overdraft then interest is charged on the amount of the overdraft on a daily basis. However this does not affect the actual workings – I work through examples in my free lectures.
Faizahmad1009
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