Help needed with Unit 15

Mrskingy

For some reason my brain seems to be struggling with holding all the information required.
I need to sit the simulation before end of March to stay on track with my study plan.
Can anyone suggest any easy way of remembering the 11 different ratio analysis, working out the cost of discount and gilt edge securities?????

My head hurts...............

:confused1:

SandyHood

working out the cost of discount

Mrskingy

I am short of time so have picked one of your questions

working out the cost of discount

If you give a customer a discount for paying you earlier than normal, you are effectively borrowing money for the period of the reduction. The interest you pay on the money you borrow is the discount you allow the customer.

Say I am your customer.

1. I normally pay 35 days after the invoice date
2. You want me to pay within 10 days
3. You are prepaed to allow me a 2% discount on my invoice totals for paying within the new time period

We need to know

1. What 2% of the amount the customer will pay is
2. How many periods of the reduced period there are in a year

1. As the company you are offering 2% of the total bill, but the customer will only pay 98%
2. So 2/98 will give you the "interest" rate for the reduced period (0.020408 or 2.0408%)
3. The reduced period is 35 days less 10 days. You are effectively borrowing the 98% for 25 days.
4. There are 365/25 periods of 25 days in a year (14.6)

So we know we are paying 2.04...% for 98% of the bill for 25 days, but we need to know the annualised equivalent rate.

There is a simple interest approach or a compound interest approach, the one you do depends on your calculator.
Can you calculate amounts to the "power of" something?

If so
take the 100% +2.04...% rate to the power of the 14.6 periods in a year.
This shows the amount borrowed plus the interest %
I make it 134.3%
Then take off the 100%
To give the annualised cost of the prompt payment discount as 34.3%

(Pretty high given the expected base rate of 0.5% by teatime today!!)

If you can't calculate, to "the powers" you will have to do a simple interest calculation.

2.04...% x 14.6 periods = 29.8%

So if you answer this sort of question in a skills test:
34.3% is right
but 29.8% can be marked as right if you add a sentence to say that you are aware that using the simple interest approach means that the answer ignores the compounding effect of interest over the year, but is a useful starting point.

A-Vic

Hi Sandy

Can i ask is this another correct way of working out the cost of discount? or have i totally messed up the sum :001_smile:

D/100-D/n-d*100

D- discount
n - normal terms
d- discount days

So say

Discount = 2%
Normal payment days = 60
Discount days = 30

nope totally forgot it

D/100-D*365/n-d*100%

2/98*365/30*100

so then the cost for the year is 24.8 - the days can be changed to months as well as the discount

Sorry just trying to remember it myself

reddwarf

I just learnt the ratios by rote, got OH to test me, and learnt which were a number or a percent. It is helpful to read up on what the significance is because then they 'mean' something and it will come up in the exam!

By the way our lecturer quoted some, like interest cover, as Net Profit before interest and tax, over interest. It took me a while to realise that is Operating Profit over Interest! (Osborne talks about Operating Profit).

At least feel free to shoot me down if I am misguided!

SandyHood

A vic

I have quoted you

D/100-D*365/n-d*100%

2/98*365/30*100

so then the cost for the year is 24.8

and then quoted myself

2.04...% x 14.6 periods = 29.8%

but 29.8% can be marked as right if you add a sentence to say that you are aware that using the simple interest approach means that the answer ignores the compounding effect of interest over the year, but is a useful starting point.

Your method is just as wrong as mine (my second one) because it is a simple interest approach. But if you say so and why, it will be marked as correct in a skills test.

You used different numbers, but if you want to check it put the same numbers I used into your formula.

D- discount
n - normal terms
d- discount days

So say

Discount = 2%
Normal payment days = 60
Discount days = 30

2/98 x 365/30 = 24.83%

I avoided this example as the days earlier (60 - 30) just happens to be the new credit period. And that could cause confusion.

Incidentally, if you can borrow from the bank at 8% p.a. or offer early payment discounts at a rate equivalent to almost 25% p.a. would you offer the early payment discount?

Would your answer change if you were worried that a client might go under very soon?

A-Vic

SandyHood wrote: »

A vic

I have quoted you


and then quoted myself




Your method is just as wrong as mine (my second one) because it is a simple interest approach. But if you say so and why, it will be marked as correct in a skills test.

You used different numbers, but if you want to check it put the same numbers I used into your formula.


2/98 x 365/30 = 24.83%

I avoided this example as the days earlier (60 - 30) just happens to be the new credit period. And that could cause confusion.

Incidentally, if you can borrow from the bank at 8% p.a. or offer early payment discounts at a rate equivalent to almost 25% p.a. would you offer the early payment discount?

Would your answer change if you were worried that a client might go under very soon?

Great thanks sandy was trying to get my head around an example that was given to me but i think am slowly getting it

:thumbup1: