Skip to content

Financial Management and Strategic Management · Management of Payables (Creditors)

Cost of Trade Credit and Cash Discount Decisions

Updated 4 October 2026 · Fact-checked

Cost of trade credit is the annualised percentage you pay by not taking a cash discount and paying late instead. Compute it as [Discount ÷ (100 − Discount)] × [365 ÷ (Credit period − Discount period)] × 100. If this cost is higher than your alternative borrowing rate, take the discount.

Understand Cost of Trade Credit and Cash Discount Decisions

Suppliers often offer terms like 2/10, net 30. This means you get a 2% discount if you pay within 10 days. Otherwise you must pay the full amount by day 30.

Trade credit looks free, but it is not free when a discount is on offer. If you skip the discount, you pay more for the same goods. That extra amount is the price of using the supplier's money for the extra days.

Take an invoice of ₹100. If you pay on day 10, you pay ₹98. If you wait till day 30, you pay ₹100. So you pay ₹2 extra to hold ₹98 for 20 more days. The rate for 20 days is 2 ÷ 98. Annualise it by multiplying by 365 ÷ 20.

The decision rule is simple. Compare this annual cost with what it costs you to raise money elsewhere, such as a bank loan or overdraft. If the cost of forgoing the discount is higher, borrow and take the discount. If it is lower, skip the discount and use the full credit period.

You can also compare in rupees. Discount earned on paying early versus the interest you save by delaying payment. The rupee method and the percentage method must give the same decision.

Key rules to remember

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.

How to solve Cost of Trade Credit and Cash Discount Decisions questions

Use the same sequence for every discount versus credit period question. It also earns step marks.

  1. 1Read the terms and write them as D/d, net N. Note whether the year is 365 or 360 days.
  2. 2Compute the cost of forgoing the discount using D ÷ (100 − D).
  3. 3Compute the number of days of extra credit, which is N − d.
  4. 4Annualise: multiply by 365 ÷ (N − d). Show it as a percentage.
  5. 5Find the alternative cost of funds, such as bank interest. Add any extra charges if given.
  6. 6Compare the two rates and state the decision in one sentence.
  7. 7If asked, support with a rupee check: discount gained versus interest cost on the net amount for N − d days.
  8. 8If the question gives several offers, repeat steps 2 to 4 for each and choose the lowest cost option.

Quickest way: Fast comparison in exam conditions

When to use it: Use for MCQs and for the first check in a written answer. The decision is usually clear without full workings.

  1. Write the fraction D ÷ (100 − D) first. For 2% it is 2/98, for 1% it is 1/99, for 3% it is 3/97.
  2. Multiply by 365 ÷ (N − d). Round only at the end.
  3. For MCQs, estimate: 2% over 20 days gives about 2.04% × 18.25 ≈ 37.2%. Treat this as an estimate only, and eliminate options far from it.
  4. Compare with the bank rate. If the bank rate is less than the cost, say take the discount.
  5. In written answers, show the formula, the substitution, the percentage and a one line conclusion. Each earns marks.

Common mistakes in Cost of Trade Credit and Cash Discount Decisions

  • Using D ÷ 100 instead of D ÷ (100 − D)

    Students treat the discount as a percentage of the invoice price, but the amount actually used is the net payment.

    Fix: Always divide by (100 − D). The money you hold is the discounted price.

  • Using N as the days instead of N − d

    The credit period is read as the full period of use.

    Fix: The extra credit you get is only the days after the discount date. Use N − d.

  • Taking the discount even when the bank rate is higher

    Students assume a discount is always good.

    Fix: Compare the two rates. Take the discount only if cost of forgoing is higher than your alternative cost of funds.

  • Ignoring the 360 or 365 day instruction

    The year basis is stated in a line students skim.

    Fix: Underline the day basis in the question. Use 365 if nothing is stated.

  • Not adjusting when payment is delayed beyond the credit period

    Students keep N as the net period even if the question says the firm pays later.

    Fix: Replace N by the actual payment day. The longer you delay, the lower the annual cost.

  • Mixing simple and effective cost

    Some questions ask for the effective rate, and students use whichever formula they remember instead of reading the question.

    Fix: Use the simple formula unless the question says effective or compound.

Worked examples

Example 1

A supplier offers terms 2/10, net 30. Your firm can borrow from a bank at 18% per annum. Using a 365 day year, find the cost of forgoing the discount and advise whether to take it.

Show the solution
  1. Terms: D = 2%, d = 10 days, N = 30 days. Extra credit days = 30 − 10 = 20.
  2. D ÷ (100 − D) = 2 ÷ 98 = 0.020408.
  3. Annualising factor = 365 ÷ 20 = 18.25.
  4. Cost = 0.020408 × 18.25 = 36.5 ÷ 98 = 0.3724, or 37.24%.
  5. Bank rate is 18%. Since 37.24% > 18%, forgoing the discount is more expensive than borrowing.

Answer: The cost of forgoing the discount is about 37.24% per annum. Borrow from the bank at 18% and take the discount.

Example 2

An invoice of ₹5,00,000 carries terms 1/15, net 45. The firm's cost of short-term finance is 15% per annum. Use a 360 day year. Find the cost of forgoing the discount and decide.

Show the solution
  1. D = 1%, d = 15 days, N = 45 days. Extra days = 30.
  2. D ÷ (100 − D) = 1 ÷ 99 = 0.010101.
  3. Annualising factor = 360 ÷ 30 = 12.
  4. Cost = 0.010101 × 12 = 0.121212, or 12.12%.
  5. Rupee check: discount = ₹5,00,000 × 1% = ₹5,000. Net payment = ₹4,95,000.
  6. Interest on ₹4,95,000 at 15% for 30 days = 4,95,000 × 15% × 30 ÷ 360 = ₹6,187.50.
  7. Interest saved by delaying (₹6,187.50) exceeds the discount lost (₹5,000), so delaying is better. This agrees with 12.12% < 15%.

Answer: The cost of forgoing the discount is about 12.12% per annum, which is below 15%. Do not take the discount. Pay on day 45.

Exam tips

  • 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.
  • Always end with a clear recommendation. A correct percentage without a decision loses marks.
  • When several suppliers are given, tabulate the cost of each offer and pick the cheapest.

Practice questions from Management of Payables (Creditors)

Cost of Trade Credit and Cash Discount Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Cost of Trade Credit and Cash Discount Decisions: frequently asked questions

What is the formula for the cost of forgoing a cash discount?

Cost = [D ÷ (100 − D)] × [365 ÷ (N − d)] × 100. Here D is the discount percentage, N is the net credit period and d is the discount period in days. Use 360 days if the question says so.

When should I take the cash discount?

Take it when the annual cost of forgoing it is higher than the cost of your alternative finance, such as a bank loan. If the cost is lower, skip the discount and pay on the last day of credit.

Why is the denominator 100 − D?

If you pay early you pay only 100 − D on every ₹100 invoice. That is the amount you effectively borrow from the supplier by delaying. The discount is the cost on that amount.

What happens to the cost if I pay later than the net due date?

The cost falls, because the same discount is spread over more days. Replace N with the actual payment day in the formula. Note that late payment may harm supplier relations or attract penalties.