Costs Homework Help


Trade credit does not involve any explicit interest charge. However, there is an implicit cost of trade credit. It depends on the credit terms offered by the supplier of goods. If the terms of the credit are, say, 45 days net, the payable amount to the supplier of goods is the same whether paid on the done of purchase or on the 45th day and, therefore, trade credit has no cost, that is, it is cost free. But if the credit terms are, say not that is, there is cash discount for prompt payment, the trade credit period beyond the cash discount period has a cost = [(Discount 1 – Discount) x (360 days Credit period – Discount period)]. The implicit interest rate cost = (0.0211 – 0.02) x (360, 45 – 15) = 24.5 per cent. Alternatively, the credit terms. Thus, net as imply that the firm (buyer) is entitled to 2 per cent discount for payment made within 15 days when the entire payment is to be made within 45 days. Since the net amount is due in 45 days, failure to take the discount means paying an extra 2 per cent for using the money form additional 30 days. If a firm were to pay 2 per cent for every 30 day period over a year, there would be as such periods (360 days + 30 days). This represents an annual interest rate cost of 24 per cent. If the terms of credit are 2/10, net 30, the cost of credit works out to 36.4 per cent. The smaller the difference between tbe payment day and the end of the discount period, the larger is the annual interest cost of trade credit.

To sum up, as the cost of track credit is generally very high beyond the discount period, firms should avail of the discount on prompt payment. If, however, they are unable to avail of discount, the payment of trade credit should be delayed till the last day of the credit (net) period and beyond without impairing their creditworthiness. But a precondition for obtaining trade credo particularly by a new company is cultivating good relationship with suppliers of goods and obtaining their confidence by honouring commitments.

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Posted by: andy

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