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

Sources and Instruments of Payables Finance for CA Intermediate

Updated 4 October 2026 · Fact-checked

Payables finance means funding your purchases through your suppliers or banks acting for them. The main tools are open-account trade credit, bills payable, letters of credit and supplier (reverse factoring) finance. To solve questions, identify the instrument, who bears the risk, and the cost, then compare it with the alternative.

Understand Sources and Instruments of Payables Finance

When a firm buys goods and does not pay at once, the supplier is financing the purchase. The amount owed sits in the balance sheet as creditors (trade payables). This is the cheapest and most spontaneous source of short-term finance, because it grows as purchases grow.

The simplest form is open-account trade credit. The supplier ships goods and sends an invoice. You pay after the credit period, for example 30 days. There is no formal paper beyond the invoice, and it rests on trust and your payment record.

A bill payable is a formal version. The supplier draws a bill of exchange on you. You accept it, which is a written promise to pay on a fixed date. The supplier can hold it to maturity or discount it with a bank to get cash early. For you it is a payable. For the supplier it is a bill receivable.

A letter of credit (LC) is a bank's undertaking, issued at the buyer's request, to pay the seller if the seller presents documents that comply with the LC terms. It replaces the seller's doubt about your credit with the bank's credit. It is common in imports and with new or distant suppliers. The bank charges a fee, and may ask for margin money or a limit.

Supplier finance (also called reverse factoring or supply chain finance) is a bank programme set up by a strong buyer. Approved supplier invoices are paid early by the bank at a discount. The discount rate is usually based largely on the buyer's credit standing. The buyer then pays the bank on the original due date, or an agreed later date. The supplier gets cash sooner and cheaper. The buyer keeps or stretches its payment period.

Trade credit versus bank credit: trade credit comes from the supplier, is tied to goods, is informal and has no direct interest unless a cash discount is lost. Bank credit comes from a lender, is a cash or non-fund facility, carries stated interest and fees, and usually needs security or a sanctioned limit.

Key rules to remember

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.

How to solve Sources and Instruments of Payables Finance questions

Use the same path for descriptive and numerical questions on payables finance.

1Read the question and name the instrument: open credit, bill payable, LC or supplier finance.
2Write who is the buyer, who is the seller and who is the bank. Mark who pays and who receives early cash.
3List the facts: invoice value, credit period, discount terms, fees, interest and days.
4Pick the correct cost formula. Use the question's day basis (365 or 360).
5Compute the annualised cost for each option on the same basis.
6Compare the options. Add non-cost points such as risk, security needed, supplier relationship and flexibility.
7State the conclusion in one sentence with the figure.
8For theory questions, define the instrument, give features, then advantages and limitations.

Quickest way: Cost first, then risk

When to use it: Use this when you have limited time in an MCQ or a short written answer.

MCQ: match the keyword. Accepted bill of exchange means bill payable. Bank undertaking against documents means LC. Buyer-led bank programme means supplier finance.
Eliminate options that mix up the parties. An LC is issued by the buyer's bank, not the seller's.
For cost sums, compute the discount fraction first, then multiply by 365 ÷ (credit period − discount period). Compare with the bank rate.
Written answer format: instrument, meaning, how it works, advantage, limitation, conclusion. Each part can earn a step mark.
Show the formula and substitution even if you are sure of the answer.

Common mistakes in Sources and Instruments of Payables Finance

Treating a bill payable as a bank loan.
Bills involve banks when discounted, so students link them to borrowing.
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.
The seller receives the money, so the seller's side seems responsible.
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.
Using the full credit period as the days in the discount cost formula.
Students overlook that the benefit starts only after the discount period.
Fix: Use credit period minus discount period as the days of extra credit.
Dividing the discount by the invoice value instead of by the amount actually paid.
The two look close and the shortcut is tempting.
Fix: Use Discount % ÷ (100 − Discount %). The money you effectively borrow is the discounted price.
Claiming trade credit is always free.
No interest appears on the invoice.
Fix: It is free only if you pay within the discount window or no discount exists. Otherwise the lost discount is an implicit cost.
Ignoring fees on an LC when comparing with open credit.
Students compare only the interest rate.
Fix: Include the LC commission and any margin money cost in the annual cost.

Worked examples

Example 1

A supplier offers terms 2/10, net 40. Invoice value is ₹5,00,000. Your bank overdraft costs 14% a year. Use 365 days. Should you take the discount?

Show the solution

Discount = 2% of ₹5,00,000 = ₹10,000, so you pay ₹4,90,000 within 10 days.
Extra credit days = 40 − 10 = 30.
Cost of forgoing discount = [2 ÷ (100 − 2)] × [365 ÷ 30].
2 ÷ 98 = 0.020408. 365 ÷ 30 = 12.1667.
0.020408 × 12.1667 = 0.24830, that is about 24.83%.
Overdraft cost is 14%, which is lower than 24.83%.

Answer: Take the discount and pay on day 10, borrowing ₹4,90,000 on overdraft. Skipping the discount costs about 24.83% a year.

Example 2

A buyer opens a 90-day letter of credit for ₹10,00,000 for an import. The bank charges a commission of 0.9% of the LC value, flat. Suppliers will otherwise sell only against immediate payment. Compute the annualised cost of the LC commission using 360 days, and state why the buyer may still choose it.

Show the solution

Commission = 0.9% of ₹10,00,000 = ₹9,000.
Days financed = 90.
Annual cost = (9,000 ÷ 10,00,000) × (360 ÷ 90).
9,000 ÷ 10,00,000 = 0.009.
360 ÷ 90 = 4.
0.009 × 4 = 0.036, that is 3.6%.
Non-cost point: the LC assures the supplier of payment, so the supplier agrees to ship and allow 90 days' credit instead of demanding immediate payment.

Answer: The annualised commission cost is 3.6%. The buyer may still choose the LC because it assures the supplier of payment, so the supplier agrees to ship and give 90 days' credit instead of demanding immediate payment.

Exam tips

Look for the day basis (360 or 365) before you start. Using the wrong one costs the final mark.
In theory answers, name the parties: buyer, seller, issuing bank. Examiners reward this clarity.
When asked to compare trade credit and bank credit, use a two-column style in bullets: source, cost, security, flexibility, documentation.
If a numerical comparison is asked, always end with a one-line recommendation. A bare number loses the conclusion mark.
For MCQs, use keywords: acceptance, documents, early payment, buyer's rating.

Practice questions from Management of Payables (Creditors)

Sources and Instruments of Payables Finance: frequently asked questions

What is the difference between trade credit and bank credit?

Trade credit comes from the supplier as deferred payment for goods, usually with no stated interest. Bank credit is a loan or non-fund facility from a bank with interest, fees and often security. Trade credit is more spontaneous, while bank credit is more formal and can fund many needs.

How does a letter of credit help in payables management?

It substitutes the bank's promise for the buyer's own credit standing. The seller is paid on compliant documents, so the supplier is more willing to deal and may allow a longer period. The buyer pays a fee and may need to give margin or use a bank limit.

What is a bill payable?

It is a bill of exchange that you have accepted, promising to pay a stated amount on a fixed date. It is shown as a liability until paid. The supplier may discount it with a bank to receive cash earlier.

What is supplier finance?

It is a bank-run programme set up around a strong buyer. Suppliers get early payment on approved invoices at a rate usually based largely on the buyer's credit standing. The buyer pays the bank on the due date, so the buyer's payables period is kept or extended.