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Hi John, I have run into a brick wall (one of many) on the effective interest rate on simple settlement discounts.
As per example 1, let’s just suppose instead of “customers currently take 3 months credit”, they take 4 months credit. The rest being the same as per the example, “we are considering offering a discount of 4% for payment within 1 month”.
4 months: $100
1 month: $96
Would the effective rate over 3 months still be: 4/96 = 0.04167?Kind regards.
If customers take 4 months credit instead of 3 months, and you offer a 4% discount for payment within 1 month, the effective rate can be calculated as you have done.
This calculation remains valid regardless of the change in the credit period, as it is based on the discount offered and the amount after the discount.However, to annualise this rate, you would typically consider the time period over which the discount is offered. If you want to annualise it, you would need to consider how many times this discount could be applied in a year.
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