CAT / FIA FFM Syllabus A. Working Capital Management - A3g & C3d. Early Settlement Discounts (Creditors) - Notes ^{3 / 4}

Clearly it is best to take as much advantage of trade credit as possible. Paying later is almost always beneficial.

However, a company needs to ensure it does not annoy its vital suppliers by missing deadlines and also the company may seek to take advantage of early settlement discounts.

How to quickly calculate an annual interest rate

1. Take 100 and divide it by 100 - discount % offered

2. Multiply this by the power of 365 / reduction in days

3. Take the 1 off and voila!

Illustration 1

5% early settlement discount if customers pay within 10 instead of 60 days.

1. Take 100 and divide it by 100 - discount % offered

   100 / (100 - 5)

2. Multiply this by the power of 365 / reduction in days

   ((100/95) power of 365/50)

3. Take the 1 off and voila!

   ((100/95) power of 365/50) - 1 = 45.42%

Illustration 2

Cow Co is considering accepting a discount of 2% from his supplier if he pays within 20 days rather than the current 35 days. 

There are 365 days in the year.

Required:
What is the annual interest rate (the compound percentage cost)?

• Annual interest rate = ((100/(100 – 2)) power of (365/15)) – 1 = 63·5%