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Credit terms/cost of trade credit

Credit terms
Purchases made on credit are due in full by the end of the billing period. Many firms extend a discount for payment made in the first part of the billing period. The original invoice contains a type of "short-hand" notation that explains the credit terms that apply (assume a 365 day year).
A) Write the short-hand expression of credit terms for each of the following

Cash discount Cash discount period Credit period Beginning of credit period
1% 15 days 45 days Date of invoice
2% 10 days 30 days End of month
2% 7 days 28 days Date of invoice
1% 10 days 60 days End of month

Answer a:

1/15 net 45 date of invoice
2/10 net 30 EOM
2/7 net 28 date of invoice
1/10 net 60 EOM

B) For each of the sets of credit terms in part A, calculate the number of days until full payment is due for invoices dated March 12
45 days
49 days (19 days in March plus 30 days)
28 days
79 days (19 days in March + 60 days)

C) If the firm's cost of short-term financing is 8%, what would you recommend in regard to taking the discount or giving it up in each case?
a) 45-15=30 days credit period is available
Cost of credit = 1%/(1-1%)*365/30=12.23%
It is advisable to take the discount by paying on 10th day as cost of credit is higher than the short term financing rate of 8%.
b) 30-10=20 days credit period is available
Cost of credit = 2%/(1-2%)*365/20=37.25%
It is advisable to take the discount by paying on 10th day as cost of credit is much higher than the short term financing rate of 8%.
c) 28-7=21 days credit period is available
Cost of credit = 2%/(1-2%)*365/21=35.47%
It is advisable to take the discount by paying on 10th day as cost of credit is much higher than the short term financing rate of 8%.
d) 60-10=50 days credit period is available
Cost of credit = 1%/(1-1%)*365/50=7.37%
It is advisable to make use of the credit as the cost of credit is lower than the short term financing rate of 8%.
Thus, take the discount in first three cases and make use of credit in the fourth case.

Solution Summary

The solution explains some questions relating to credit terms and cost of trade credit

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