Management of Payables (Creditors): formula sheet

Key formulas

Trade payables turnover ratio (creditors turnover)

Credit purchases ÷ Average trade payables

If credit purchases are not given, use total purchases and state your assumption. Average payables = (Opening + Closing) ÷ 2.

Average payment period (in days)

(Average trade payables ÷ Credit purchases) × 365

Equivalent to 365 ÷ payables turnover. Use the number of days the question specifies (360 or 365).

Payables period in the operating cycle

Cash conversion cycle = Inventory days + Receivable days − Payable days

A longer payable period shortens the cash conversion cycle and reduces working capital needs.

Trade payables as a source of finance

Finance from creditors ≈ Daily purchases × Credit period

Use this to estimate the average funds supplied by creditors.

Cost of forgoing cash discount (simple)

Cost = [D ÷ (100 − D)] × [365 ÷ (N − d)] × 100

D = discount %, N = net credit period in days, d = discount period in days. Use 360 days if the question says so.

Cost with compounding (effective)

Effective cost = {[1 + D ÷ (100 − D)]^(365 ÷ (N − d)) − 1} × 100

Multiply by 100 to express the result as a percentage, as in the simple formula. Some questions ask for the effective or compounded rate. Use this form only when the question asks for it. Check: for 2/10, net 30 on a 365 day year, the effective cost is about 44.6%.

Decision rule

Take discount if cost of forgoing > cost of alternative finance

If equal, you are indifferent. If lower, pay on the last day of credit.

Amount paid on discount

Net payment = Invoice × (1 − D%)

Use this for rupee comparison of discount versus interest saved.

Stretching payment beyond the credit period

Cost = [D ÷ (100 − D)] × [365 ÷ (Actual payment day − d)] × 100

Replace N by the day you actually pay. Delay lowers the annual cost.

Cost of forgoing cash discount (simple, annualised)

Cost = [Discount % ÷ (100 − Discount %)] × [365 ÷ (Credit period − Discount period)]

Use 360 days if the question says so. Credit period and discount period are in days from invoice date.

Cost of forgoing cash discount (compound, effective)

Effective cost = [1 + Discount % ÷ (100 − Discount %)]^(365 ÷ (Credit period − Discount period)) − 1

Use only when the question asks for the effective or compounded rate.

Decision rule

Take the discount if cost of forgoing > cost of short-term borrowing; otherwise pay on the last day

Compare like with like: both rates annual, both simple or both effective.

Payables deferral period

Average payables ÷ (Credit purchases ÷ 365)

Gives the average days you take to pay. Use purchases, not sales.

Net benefit of taking discount

Discount saved − Interest on funds used to pay early

Interest = Amount paid × borrowing rate × (days advanced ÷ 365).

Cost of forgoing cash discount (simple)

Cost = [Discount % ÷ (100 − Discount %)] × [365 ÷ (Credit period − Discount period)]

Use 360 days if the question says so. Credit period and discount period are both counted in days from the invoice date.

Cost of LC or bank charge (annualised)

Annual cost = (Fee ÷ Amount financed) × (365 ÷ Days financed)

Add interest and fees together if both apply. Check whether the fee is on the full LC value.

Cost of supplier finance discounting (simple)

Annual rate = [Discount ÷ (Invoice value − Discount)] × (365 ÷ Days advanced)

Days advanced is the period between early payment and the original due date.

Net cost after tax

After-tax cost = Pre-tax cost × (1 − tax rate)

Apply only if the question says the financing charge is tax deductible.

Decision rule

Choose the source with the lowest annualised cost, after checking risk and availability

If cost of forgoing discount is higher than bank borrowing rate, take the discount and borrow.

Quick revision

• Trade credit is spontaneous, short-term finance from suppliers.
• Terms 2/10, net 30 mean 2% discount within 10 days, full payment by day 30.
• Cost of forgoing discount (simple) = Discount ÷ (100 − Discount) × 365 ÷ (Credit period − Discount period).
• The base is the net amount you would pay, which is 100 − Discount, not 100.
• Days used in the formula are the extra days you get by not paying early.
• If cost of forgoing discount > cost of bank finance, take the discount.
• If cost of forgoing discount < cost of bank finance, forgo the discount and pay on the last day.
• Stretching payment beyond the credit period can bring penalties and damage supplier relations.
• Compare all costs on the same annual basis before deciding.
• Use 365 days unless the question says 360.
• State your decision in one clear sentence at the end of the answer.

Common mistakes

• Calling trade credit always free. Fix: Say it is free only if you pay within the period and no discount is lost. Skipping a cash discount gives an implicit cost.
• Using total purchases when credit purchases are given. Fix: Read the data carefully. Use credit purchases for the payables ratio and state your assumption if only total purchases are available.
• Using D ÷ 100 instead of D ÷ (100 − D) Fix: Always divide by (100 − D). The money you hold is the discounted price.
• Using N as the days instead of N − d Fix: The extra credit you get is only the days after the discount date. Use N − d.
• Using d ÷ 100 instead of d ÷ (100 − d). Fix: Always write the denominator as the net amount paid, 100 − d.
• Using the full credit period as the days in the exponent. Fix: Use credit period minus discount period. Only those extra days are financed.
• Treating a bill payable as a bank loan. Fix: A bill payable is a trade obligation accepted by the buyer. The bank is involved only if the seller discounts the bill.
• Saying the seller's bank issues the LC. Fix: The LC is opened by the buyer's bank (issuing bank) at the buyer's request. The seller's bank may advise or confirm it.

Exam tips

• For theory, structure the answer as meaning, why used, objectives, benefits and risks. Five clear headings in points earn more than one long paragraph.
• In numericals, show the formula and the basis (credit purchases, average payables, 365 days) so you get step marks even if the arithmetic slips.
• Always add a line of interpretation. Examiners reward the link to liquidity and the cash conversion cycle.
• For MCQs, avoid extreme options such as always or never. Trade credit questions usually reward a balanced answer.
• Revise this topic together with cost of trade credit and the cash conversion cycle, since numerical questions often combine them.
• Write the formula, the substitution and the final percentage on separate lines. Step marks depend on this.
• Check the day basis (360 or 365) before you start.
• In MCQs, estimate quickly with D ÷ (100 − D) × 365 ÷ (N − d) and eliminate options that are far away.