This preview shows page 1. Sign up to view the full content.
Unformatted text preview: firm would reduce its investment in operations by $67,710.
Clearly, if this action did not damage MAX’s credit rating, it would be in the
company’s best interest. Analyzing Credit Terms
The credit terms that a firm is offered by its suppliers enable it to delay payments
for its purchases. Because the supplier’s cost of having its money tied up in merchandise after it is sold is probably reflected in the purchase price, the purchaser
is already indirectly paying for this benefit. The purchaser should therefore carefully analyze credit terms to determine the best trade credit strategy. If a firm is
extended credit terms that include a cash discount, it has two options—to take
the cash discount or to give it up.
Taking the Cash Discount If a firm intends to take a cash discount, it
should pay on the last day of the discount period. There is no cost associated with
taking a cash discount.
EXAMPLE cost of giving up a cash discount
The implied rate of interest paid
to delay payment of an account
payable for an additional number
of days. EXAMPLE Lawrence Industries, operator of a small chain of video stores, purchased $1,000
worth of merchandise on February 27 from a supplier extending terms of 2/10
net 30 EOM. If the firm takes the cash discount, it must pay $980 [$1,000
(0.02 $1,000)] by March 10, thereby saving $20.
Giving Up the Cash Discount If the firm chooses to give up the cash discount, it should pay on the final day of the credit period. There is an implicit cost
associated with giving up a cash discount. The cost of giving up a cash discount is
the implied rate of interest paid to delay payment of an account payable for an
additional number of days. In other words, the amount is the interest being paid
by the firm to keep its money for a number of days. This cost can be illustrated by
a simple example. The example assumes that payment will be made on the last
possible day (either the final day of the cash discount period or the final day of
the credit period).
In the preceding example, we saw that Lawrence Industries could take the cas...
View Full Document