Friday, August 5, 2011

Cost of Trade Credit

The rate of discount benefit sacrificed by the business for making payment after a certain time period in future whether then making payment earlier by enjoying discount benefit is known as cost of trade credit for making rate in payment the  supplier may impose late payment penalty that is also a part of cost of trade credit. 

This cost is known as visible cost of trade credit. The loss of reputation or goodwill of the business sector for making less payment against trade credit and loss of availability of suppliers for purchasing required items or materials are known as invisible or hidden cost of trade credit.
We can also distinguish between prompt payment and delayed payment practices. By prompt, we mean those situations in which the firm pays off the trade credit exactly on time. There are two such possibilities. 
If a cash discount is offered, paying on time means paying on the discount date. But if cash discount is not offered, prompt payment means payment on the due date. However, if a cash discount is offered but not taken, or if the full bill is not paid by the due date, the firm is making a delayed payment.

Suppose a firm sale $100 on credit are 2/15, net 75
Now the cost of trade credit = x/100-x*365/ (z-y)
[x=2, y=15, z= 75]
= 2/100-2 * 365/75-15
= 2/98 * 365/60
= .1241%
= 12.42%

But if the credit terms are 2/5, net 75 and stretches payable is 20 days, than
The cost of trade credit = x/100-x*365/ (z+ k-y)
[x=2, y=15, z= 75, k= 20]
= 2/100-2 * 365/75+20-15
= 2/98 * 365/80

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