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Questions and Answers
What is the importance of managing creditors?
What is the importance of managing creditors?
Managing creditors is crucial for effective cash management and helps enhance the cash position of a company.
Which of the following is a cost of availing trade credit?
Which of the following is a cost of availing trade credit?
Which statement is true about the costs of not taking trade credit?
Which statement is true about the costs of not taking trade credit?
What does the 'd' represent in the formula for nominal cost?
What does the 'd' represent in the formula for nominal cost?
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How is the cost of lost cash discounts estimated?
How is the cost of lost cash discounts estimated?
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The implied cost of interest per annum if ABC Ltd. does not avail the cash discount is approximately ____%.
The implied cost of interest per annum if ABC Ltd. does not avail the cash discount is approximately ____%.
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Study Notes
Introduction to Payables Management
- Effective management of creditors and suppliers is crucial for maintaining good business relationships and ensuring smooth operations.
- Trade creditors serve as a short-term source of finance, arising from normal business transactions.
- Timely payment to creditors is essential to avoid disrupting supply chains and maintaining a positive company image.
Costs and Benefits of Trade Credit
Cost of Availing Trade Credit
- Price Discounts: Trade credit may involve discounts that can lead to implicit costs if payments are delayed.
- Loss of Goodwill: Overstepping credit terms may result in suppliers prioritizing other customers, damaging the company's reputation.
- Management Costs: There are administrative and accounting costs associated with managing creditor relationships.
- Minimum Order Conditions: Suppliers may require a minimum order size or frequency to extend credit facilities.
Cost of Not Taking Trade Credit
- Inflation Impact: Inflation can favor borrowers by allowing them to repay fixed loans later, potentially increasing overall costs due to higher prices.
- Interest Costs: Not utilizing trade credit is equivalent to missing out on an interest-free loan, especially significant when interest rates are high.
- Supplier Inconvenience: Suppliers may face difficulties if they rely on expected deferred payments.
Computation of Cost of Payables
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Judicious use of trade credit can alleviate the financial burden associated with working capital investments.
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A formula exists to calculate the annual nominal cost of not taking available discounts, considering the discount percentage (d) and the time reduction necessary to avail discounts (t).
[ \text{Cost} = \frac{d \times 365}{100 - d} \times t ]
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An alternative formula for estimating the cost of lost cash discount considers compounding effects:
[ \text{Cost} = \left(\frac{365}{100} \times t \right)\left(1 - \frac{100}{100 - d}\right) ]
Illustration of Trade Credit Evaluation
- Example: ABC Ltd. is offered credit terms of 2/10, net 45, meaning a 2% discount for payments within 10 days or full payment within 45 days.
- Evaluation requires comparing the cost of taking the discount (paying ₹98 today instead of ₹100 later) against the opportunity cost of using the ₹98 for 35 days.
- If the discount is not taken, the implied cost of interest calculated indicates an annual cost of approximately 23.5% for delaying payment.
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Description
This quiz focuses on the management of payables in financial management, specifically within Unit V. Understanding how to effectively manage creditors and suppliers is crucial for business operations and financial health. Test your knowledge on this important aspect of financial management.
