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I understand the equation is the same as that for receivables but i dont get what the decision rule is.
For receivables, since the effective rate is the cost of giving the discount, it should only be offered if its cheaper than financing through the overdraft.
So how is it for payables?
i’m really confused…- Topics: 1
- Replies: 87
- ☆☆
It is worthwhile accepting the discount from a supplier If the cost of financing the discount (i.e the overdraft rate x by the reduction in credit period allowed) is LESS THAN the amount of the discount.
Example
A supplier offers a discount of 2% on an invoice of $7,500 if the invoice is paid within one month instead of the three months normally taken to pay. Assume, the O/D rate is 10%. Is it financially worthwhile to accept the discount and pay early?Answer:
Discount offered saves 2% of $7,500 = $150
Financed by overdraft for the extra 2 months
Cost = 10% x 2/12 x $7,500 = $125Net Saving = $25 ……..DECISION: It is worth accepting the discount
Hope this has helped
Regards, Kevin Kelly
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