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Unformatted text preview: light of certain bank
borrowing costs. However, other factors relative to payment strategies may also
need to be considered. For example, some firms, particularly small firms and
poorly managed firms, routinely give up all discounts because they either lack
alternative sources of unsecured short-term financing or fail to recognize the
implicit costs of their actions. TABLE 15.1 Cash Discounts and
Associated Costs for
Mason Products Credit terms Approximate
cost of giving up
a cash discount A 2/10 net 30 EOM 36.0% B 1/10 net 55 EOM 8.0 C 3/20 net 70 EOM 21.6 D 4/10 net 60 EOM 28.8 Supplier 640 PART 5 Short-Term Financial Decisions Effects of Stretching Accounts Payable
stretching accounts payable
Paying bills as late as possible
without damaging the firm’s
credit rating. EXAMPLE A strategy that is often employed by a firm is stretching accounts payable—that
is, paying bills as late as possible without damaging its credit rating. Such a strategy can reduce the cost of giving up a cash discount.
Lawrence Industries was extended credit terms of 2/10 net 30 EOM. The cost of
giving up the cash discount, assuming payment on the last day of the credit
period, was found to be approximately 36% [2% (360 20)]. If the firm were
able to stretch its account payable to 70 days without damaging its credit rating,
the cost of giving up the cash discount would be only 12% [2% (360 60)].
Stretching accounts payable reduces the implicit cost of giving up a cash discount.
Although stretching accounts payable may be financially attractive, it raises
an important ethical issue: It may cause the firm to violate the agreement it
entered into with its supplier when it purchased merchandise. Clearly, a supplier
would not look kindly on a customer who regularly and purposely postponed
paying for purchases. Accruals
Liabilities for services received
for which payment has yet to be
made. EXAMPLE The second spontaneous source of short-term business financing is accruals.
Accruals are liabilities for services received for which payment h...
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