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Product Q
The annual demand for Product Q is 456,000 units and Plot Co purchases this product at $1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for settlement of invoices within 20 days.
Other information
Plot Co holds no cash and finances working capital with short-term finance costing 5% per year. Assume that there are 365 days in each year.
Which TWO of the following are potential advantages for Plot Co of accepting the early payment discount for Product Q?
a. A shortening in the operating cycle
b. An increase in profit margins
c. Improved business reputation
d. An increase in the current ratioThe correct answer is B and C
Can you please tell me why Option D is incorrect ?
I chose option D because as you get a early payment discount , you would pay earlier than before hence reducing current liabilities leading to current assets bigger than current liabilities which would mean an increase in the current ratio.
Using random values Current Assets Ratio :
Before discount – current assets of 100/ current liabilities of 150 = 0.67
After discount – current assets of 100/ current liabilities of 50 = 2Option D is incorrect because accepting the early payment discount for Product Q would not directly result in an increase in the current ratio.
Accepting the early payment discount would affect the cash position of Plot Co, but it would not directly impact the current assets or liabilities. Therefore, it would not lead to an increase in the current ratio.
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