2.4 MANAGING CURRENT LIABILITIES

Question 1

What do credit terms like “2/10, net 30” mean?

Answer 1

It means a 2% discount is offered if payment is made within 10 days, otherwise the full amount is due in 30 days

Question 2

What is the cost of not taking the 2% discount in “2/10, net 30” terms?

Answer 2

The cost is equivalent to the interest charged for delaying payment from day 10 to day 30 (20 days)

Question 3

What is the formula of Annual Percentage Rate (APR) ?

Answer 3

APR = ( Interest * Principal ) × ( 1* Time )

Question 3

How can the cost of not taking the 2% discount be calculated?

Answer 3

For a $100 invoice, the cost is $2 (2% of $100).
The Annual Percentage Rate (APR) can be calculated as:

( 2* 98) × [ 1* (20*365) ] = 37.24%

Question 4

What are the advantages of offering cash discounts like “2/10, net 30”?

Answer 4

It can shorten the average collection period for accounts receivable and improve cash flow.

Question 5

What are the disadvantages of offering cash discounts?

Answer 5

The main disadvantage is the cost to profitability due to the lost revenue from the discount.