Intro to Finance: Working Capital Management - Payables Management, Trade Credit Discounts Stretching Payables

What This Is

Payables management involves the process of managing a company's short-term debt, specifically trade credit, discounts, and stretching payables. This is crucial in finance as it directly affects a company's liquidity, cash flow, and overall financial health. For instance, if Apple Inc. takes 60 days to pay its suppliers, it can delay payment by 30 days to stretch its payables, saving $10 million in interest expenses.

Key Formulas & Symbols

• Trade Discount = List Price × Discount Rate where List Price = original price, Discount Rate = percentage discount offered.
• Trade Discount Rate = (1 - Discount Rate) × 100 where Discount Rate = percentage discount offered.
• Stretching Payables = (Days to Pay × Interest Rate) / 360 where Days to Pay = number of days to pay, Interest Rate = annual interest rate.
• Net Payable = Gross Payable × (1 - Discount Rate) where Gross Payable = total amount payable, Discount Rate = percentage discount offered.
• Payable Period = Days to Pay / 360 where Days to Pay = number of days to pay.
• Payable Interest = (Gross Payable × Interest Rate) / 360 where Gross Payable = total amount payable, Interest Rate = annual interest rate.
• Payable Value = Gross Payable × (1 + Payable Interest) where Gross Payable = total amount payable, Payable Interest = interest on payable.

Step-by-Step Calculation

1. Calculate the trade discount: List Price × Discount Rate = $100,000 × 2% = $2,000.
2. Calculate the trade discount rate: (1 - Discount Rate) × 100 = (1 - 2%) × 100 = 98%.
3. Calculate the payable period: Days to Pay / 360 = 60 / 360 = 0.167 years.
4. Calculate the payable interest: (Gross Payable × Interest Rate) / 360 = ($100,000 × 8%) / 360 = $2,222.
5. Calculate the payable value: Gross Payable × (1 + Payable Interest) = $100,000 × (1 + $2,222 / $100,000) = $102,222.

Common Mistakes

• Mistake: Forgetting to calculate the payable interest when stretching payables.
• Correction: Always calculate the payable interest to determine the actual interest saved.
• Mistake: Confusing the payable period with the days to pay.
• Correction: The payable period is calculated by dividing the days to pay by 360, while the days to pay is the actual number of days to pay.
• Mistake: Not considering the interest rate when calculating the payable value.
• Correction: The payable value should include the interest saved on the payable.

Exam / CFA Tips

• Tip: Be careful with the units when calculating the payable interest and payable value.
• Tip: Make sure to calculate the payable period correctly to avoid confusion.
• Tip: Consider the interest rate when calculating the payable value to avoid underestimating the interest saved.

Quick Practice Problem

Tesla Inc. offers a 3% discount on its invoices. If the invoice amount is $50,000, what is the trade discount?

Answer: $1,500 Explanation: Trade Discount = List Price × Discount Rate = $50,000 × 3% = $1,500.

Last-Minute Cram Sheet

• The payable period is calculated by dividing the days to pay by 360.
• The trade discount rate is calculated by subtracting the discount rate from 1.
• The payable interest is calculated by multiplying the gross payable by the interest rate and dividing by 360.
• The payable value is calculated by adding the payable interest to the gross payable.
• The payable interest is not the same as the interest rate.
• The payable period is not the same as the days to pay.
• The payable value should include the interest saved on the payable.
• The trade discount is calculated by multiplying the list price by the discount rate.