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Dear sir,
I have certain doubts.1. If a company accepts an early settlement discount offered by suppliers, does it lead to a higher current ratio or increased reputation?
2. Is there any easy way to understand how to calculate the net benefit if a company accepts an early settlement discount offered by a supplier?
3. Does selling inventory at a loss reduce or increase quick ratio?
Thanks!
1. A higher current ratio (cash will fall by less than the fall in payables). It has nothing to do with reputation.
2. You need to watch my free lectures on the managements of receivables.
3. Inventory doesn’t come into the quick ratio. If cash is received then this increases the quick ratio.
Dear sir,
1. this qn was actually a part of a Section B mock question relating to early settlement discount. The answer says that the early pay off to suppliers leads to an increase in the cash operating cycle and will hence increase the overdraft causing it to remain unchanged. Is this true?
2. I have watched your lecture on receivables and have understood it clearly. However when it comes to payables, I’m confused as to how to go about it. Can you explain this to me with the help of an example?
Thanks!
1. Your original question asked about the current ratio and not about the operating cycle, and did not mention that they were running an overdraft. I need to see the whole question – if it is in the current edition of the BPP Revision Kit then tell me which mock exam and which question.
2. All you can be asked to do with regard to payables is what I explain in my lecture on the management of payables, and I work through an example in the lecture.
Dear sir,
My apologies! Here is the actual question from the becker mock paperTerrier Co makes annual purchases of $342,000 for a key component. It places one order per month for 5,000 components. The current terms are payment in full within 90 days, which Terrier Co meets, and the cost per component is $5·70.
The cost of ordering is $100 per order, while the cost of holding components in inventory is $0·50 per component per year. Terrier Co does not use the Economic Order Quantity (EOQ) model for inventory. The supplier has offered either a discount of 0·8% for payment in full within 30 days, or a discount of 3% on orders of 15,000 or more components.
If the bulk purchase discount is taken, the cost of holding components in inventory would increase to $1 per component per year due to a scarcity of warehousing space in the city.
Assume that there are 365 days in the year and that Terrier Co finances working capital using an overdraft costing 4.5% per year.
Which of the following are additional possible benefits if Terrier Co accepts the early settlement discount?
(1) Improved business reputation
(2) Shorter operating cycle
3) Higher current ratioA 3 only
B 1 and 3 only
C 1 and 2 only
D 1, 2 and 3Also, related to this qn, how do you calculate this?
What is the net benefit per year if Terrier Co accepts the early settlement discount?
A $2,713 B $2,736 C $206 D $1,471Thanks!
1. Yes – what they wrote in the answer is true. Inventory will increase and the overdraft will increase, so the current ratio will not change.
2. With regard to the benefit of accepting the early settlement discount, the annual saving on the discount is easy: 0.8% x $342,000.
Because they will be paying 60 days earlier, there will be extra overdraft interest of 4.5% x 60/365 x $342,000 (exactly the same logic as that which we use for receivables).
The net benefit is the difference between the two.(The higher discount, the ordering costs and the holding cost are all irrelevant for this part of the question because we are not considering the bulk discount)
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