In my earlier article on Overtrading where due to cash shortage, the company is unable to take advantage of suppliers’ discount by paying accounts promptly.

This so-called cost of cash inadequacy can be easily computed based on the approximate annual cost of not taking the cash discount from our suppliers.

The formula is as follows:

(% Cash Discount x 100 ) X (360 Days)

(100% -% Cash Discount) (Date for Net Payment – Date for Discount Payment

Illustration:

Suppose a supplier offers credit terms of “2 per cent, 10 days: net 30 days from date of invoice, what is then the cost involved of not taking advantage of paying promptly.

Let’s understand what is the underlying meaning of the term offer by the supplier:

it means that the customer may deduct 2 per cent from the invoice amount if it pays within 10 days of the invoice date.

Applying the above formula, we get :

2 x100 X 360

98 30-10

=2.04% X 18 =36.7%

To the buying company or the customer, the implications can be interpreted as follows:

• By paying its accounts 20 days later than the discount date, it is in effect borrowing money at an annual interest rate of about 37% However if the company can readily borrow at less than 36.7% per annum from its bank, then for a $100 invoice, it could borrow $98 from the bank to pay the supplier within the discount period. This would be cheaper than paying the supplier $2 for the loan of $98 for 20 days

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