Skip to content

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

Credit Period Evaluation and Payment Policies for CA Inter FM

Updated 4 October 2026 · Fact-checked

Credit period evaluation compares supplier terms, such as a cash discount for early payment versus paying at the end of the credit period. Compute the annualised cost of forgoing the discount, compare it with your borrowing rate, and pay early only if the discount costs less than what you would pay to borrow.

Understand Credit Period Evaluation and Payment Policies

Trade credit is the time a supplier gives you to pay for goods. It looks free, but it is not always. Many suppliers offer a cash discount if you pay early, and you give up that discount if you take the full credit period.

So each supplier offer is really a choice between two options. Option one: pay early and take the discount. Option two: pay late and keep your cash for longer. The extra days you hold the cash are bought at the price of the discount you lose. That price is the cost of trade credit, stated as an annual rate.

You then compare it with your next best source of funds, such as a bank overdraft or cash credit. If the cost of forgoing the discount is higher than the bank rate, borrow and pay early. If it is lower, use the credit and pay late.

Stretching payables means paying after the due date, past the agreed credit period. It saves cash for a while. But it can cost you: late-payment interest, loss of discounts, a poor supplier rating, stricter terms, stopped supplies or higher prices. It also hurts your credibility with banks.

A payment policy is your rule for when to pay. A conservative policy pays early and takes discounts. An aggressive policy pays as late as possible. A balanced policy pays on the due date, or takes discounts when they beat your cost of funds. The right choice depends on your cost of funds, your liquidity, and how much you depend on the supplier.

Key rules to remember

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).

How to solve Credit Period Evaluation and Payment Policies questions

Use this method for any question that gives supplier terms such as 2/10 net 45 and asks what to do.

  1. 1Write the terms clearly: discount %, discount period, credit period (net days).
  2. 2Work out the net amount paid if you take the discount, per ₹100 of invoice: 100 − discount %.
  3. 3Find the days gained by paying late: credit period − discount period.
  4. 4Compute the annualised cost of forgoing the discount using the formula. Use 365 or 360 as the question states.
  5. 5Write the cost of your alternative funds: bank rate, opportunity cost or return on surplus cash.
  6. 6Compare the two rates. State the decision in one line.
  7. 7If several options exist, such as different discounts or stretching, compute each and pick the cheapest or most beneficial.
  8. 8Add a short note on non-cost factors: supplier relationship, liquidity and penalty for late payment.

Quickest way: Fast comparison of credit terms

When to use it: Use this for MCQs and for the first line of any written answer on credit terms.

  1. Compute d ÷ (100 − d) first, for example 2 ÷ 98 = 2.04%.
  2. Multiply by 365 ÷ days gained. For 2/10 net 30 that is 365 ÷ 20 = 18.25, so cost ≈ 37.2%.
  3. Compare with the bank rate. If the bank rate is far lower, take the discount.
  4. In MCQs, eliminate options that use d ÷ 100 instead of d ÷ (100 − d), or the wrong number of days.
  5. In written answers, show the formula, the substitution and a one-line conclusion. Each step earns marks even if the final value is slightly off.

Common mistakes in Credit Period Evaluation and Payment Policies

  • Using d ÷ 100 instead of d ÷ (100 − d).

    Students forget that the amount actually paid after the discount is 100 − d, which is the true amount of financing.

    Fix: Always write the denominator as the net amount paid, 100 − d.

  • Using the full credit period as the days in the exponent.

    The discount period is overlooked.

    Fix: Use credit period minus discount period. Only those extra days are financed.

  • Comparing a simple rate with an effective rate.

    Students compute one cost and compare it with a differently stated bank rate.

    Fix: Put both on the same basis before deciding. State the basis in your answer.

  • Ignoring non-cost risks of stretching payables.

    The numbers give a clear answer, so the qualitative part is skipped.

    Fix: Add one or two lines on supplier relations, credit rating, late-payment charges and supply continuity.

  • Taking the discount just because the discount cost looks high without checking the funds source.

    Students forget that paying early needs cash or borrowing.

    Fix: Compare with the cost of the funds actually used. If funds are costlier than the discount cost, do not pay early.

  • Using sales instead of purchases for payables deferral period.

    Confusion with the receivables formula.

    Fix: Payables relate to credit purchases. Use credit purchases ÷ 365 as the denominator.

Worked examples

Example 1

A supplier offers terms of 2/10 net 40. Your bank charges 18% p.a. on overdraft. Should you take the discount? Use 365 days and the simple method.

Show the solution
  1. Discount = 2%; discount period = 10 days; credit period = 40 days.
  2. Days gained by paying late = 40 − 10 = 30 days.
  3. Cost of forgoing = [2 ÷ (100 − 2)] × [365 ÷ 30].
  4. 2 ÷ 98 = 0.020408.
  5. 365 ÷ 30 = 12.1667.
  6. Cost = 0.020408 × 12.1667 = 0.2483, which is 24.83% p.a.
  7. Bank rate is 18%. The cost of forgoing the discount (24.83%) is higher than 18%.

Answer: Take the discount and pay on day 10, financing the payment by overdraft. The cost of forgoing is about 24.83% against 18% for the overdraft.

Example 2

A firm buys goods worth ₹10,00,000 on terms 1/15 net 45. It can borrow at 12% p.a. Compute the net benefit or loss of paying on day 15 instead of day 45 using borrowed money. Use 365 days.

Show the solution
  1. Discount = 1% of ₹10,00,000 = ₹10,000.
  2. Amount paid on day 15 = ₹10,00,000 − ₹10,000 = ₹9,90,000.
  3. Days advanced = 45 − 15 = 30.
  4. Interest on ₹9,90,000 at 12% for 30 days = 9,90,000 × 0.12 × 30 ÷ 365.
  5. 9,90,000 × 0.12 = ₹1,18,800.
  6. 1,18,800 × 30 ÷ 365 = ₹9,764 (approx.).
  7. Net benefit = ₹10,000 − ₹9,764 = ₹236 (approx.).
  8. Cross-check: cost of forgoing = (1 ÷ 99) × (365 ÷ 30) = 12.29%, slightly above 12%, so a small gain is consistent.

Answer: Paying on day 15 gives a small net benefit of about ₹236. The cost of forgoing the discount is about 12.29% against the 12% borrowing rate, so the firm should marginally prefer to take the discount.

Exam tips

  • Read the terms carefully. Note whether the question says 360 or 365 days and simple or effective rate, and follow it.
  • Show the formula and each substitution. Step marks are given even when arithmetic slips.
  • End every numerical answer with a clear decision sentence comparing the two rates.
  • For theory questions on stretching payables, give both benefits and risks, and name a balanced policy as the practical choice.
  • If the question gives average payables and purchases, compute the payables deferral period and link it to the operating cycle.

Practice questions from Management of Payables (Creditors)

Credit Period Evaluation and Payment Policies: frequently asked questions

What does stretching accounts payable mean?

It means paying suppliers after the agreed due date. It keeps cash in the business longer. But it can bring late-payment charges, lost goodwill, tougher terms and supply disruption.

How do I evaluate credit terms from suppliers in FM?

Find the annualised cost of forgoing the cash discount. Compare it with your cost of short-term funds. If the discount cost is higher, pay early; if lower, use the full credit period.

What is the payables deferral period?

It is the average number of days a firm takes to pay its suppliers. Compute it as average payables divided by daily credit purchases. A longer period helps cash flow but can strain supplier relations.

What is an effective payables management policy?

It balances cost and relationship. Take discounts when their cost beats your borrowing rate, pay on the due date otherwise, and avoid stretching beyond terms unless the cost and risk are clearly acceptable.