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sir
in the lectures
the fall in receivables was multiplied with the overdraft rate , could you please tell me why did we multiply the fall in receivables with the overdraft rate…and whats the benefit or the reason for calculating effective % cost per annum of the discount ?
I receivables fall then it means we are receiving cash sooner, which means we can reduce the overdraft and therefore save interest.
We calculate the effective cost p.a. of the discount in order to compare with the overdraft cost p.a. so as to be able to decide whether or not it is worth offering the discount.
Yes sir thank you now
I understand that in a companyWhen there are too much of receivables it’s quite common for the company to obtain a bank loan and purchase the raw materials or a non current assets.
So as per what I think
There are two situationsSituation 1 – more receivables
Situation 2 – we take bank loansSo it is to manage the above two situations that we give early settlement discounts etc
So that
When receivables fall then it means we are receiving cash sooner, which means we can reduce the overdraft and therefore save interest.But still I cannot understand
Overdraft %
And effective cost % per annum sirI’m actually new to this sir
You say that you are new to this, but you have presumably passed Paper FA (was F3) or if you were exempt then studied the topics at university. You should therefore know that an overdraft is a negative bank balance on which the company will be having to pay interest.
If it possible to collect money from receivables sooner (by offering them a discount for earlier payment) then the money can be used to reduce the overdraft and save bank interest.
However offering a discount is costing the company money, so we need to compare the cost of giving the discount with the saving of bank interest. If it the discount is costing the company less than the interest saved by having a lower overdraft then it is worth offering the discount. If, on the other had, the cost of offering the discount is greater than the bank interest that would be saved, it is not worth offering the discount.
Oh ok sir thank you so much
1)To be honest I do know what an overdraft is
But sir the overdraft % is the factor which was confusing me but now I understand that overdraft % is the cost of offering the discount am I right sir2) and Sir is my second reply above correct ( regarding the situation 1 and situation 2 )
1. An overdraft is simply a negative bank balance. It is not a loan (which when a fixed amount is borrowed for a fixed period). An overdraft changes from day to day (just as a bank balance that is in credit changes from day to day), and interest is charged on the overdraft.
The overdraft % is the rate of interest that is charged on the overdraft. It is not the cost of offering the discount – I show how that is calculated in my lectures.
The two alternative situations are:
Either we do not offer a discount in which case receivables stay as they are, the bank overdraft stays as it is, and we pay interest on the overdraft.
Or, we offer a discount in which case receivables pay sooner, so the overdraft reduces and we therefore pay less overdraft interest.
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