Question

It is significant to finance with accounts payable because it is still obtaining finance, even with a delayed payout. The benefits of the significance of financing with accounts payable consist of improved cash flow, no interest, relationships with the supplier, and even increased flexibility of the financials. This shows that it has potential, and just like everything else, it has possible downsides. But it helps the business by allowing it to extend its payment terms and gain more appreciation from the consumers.

Explain (including computations) the rationale of taking a cash discount, such as 3/15, n/40.

Answer 1

Taking a cash discount such as 3/15, n/40 can provide significant cost savings and is often more advantageous than incurring the potential higher costs associated with other forms of short-term financing.

Step-by-step explanation:

The rationale behind taking a cash discount with terms such as 3/15, n/40 is rooted in the benefits associated with cost savings and improved cash flow management. The terms offered mean that the buyer can take a 3% discount on the invoice price if the payment is made within 15 days; otherwise, the net full amount (n) is due in 40 days.

By paying early, a firm can save a significant percentage, which, when annualized, often exceeds typical interest rates that would be paid on borrowed funds.

For example, if a firm has an invoice of $1,000 with terms 3/15, n/40, they can pay $970 within 15 days, saving $30. If this firm instead chooses to pay on the 40th day, they are effectively giving up the chance to save 3% on their initial invoice sum. Calculating the annual cost of foregoing this discount elucidates the incentive to take advantage of the cash discount. The annualized interest rate of not taking the discount is substantial, and by foregoing this, a firm would be incurring an opportunity cost that could potentially be higher than obtaining other forms of short-term financing.