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CFA Level I Exam · Working Capital and Liquidity

Managing Receivables, Inventory and Payables for CFA Level I

Updated 7 October 2026 · Fact-checked

Managing receivables, inventory and payables means balancing the cost of tying up cash against sales, supply and liquidity benefits. Credit policy and aging control receivables, methods like JIT and EOQ control inventory, and the cost of trade credit decides whether to take an early payment discount or pay late.

Understand Managing Receivables, Inventory and Payables

Working capital is the cash a firm ties up in day-to-day operations. Three items drive most of it: money customers owe you (receivables), goods you hold for sale (inventory) and money you owe suppliers (payables). Managing them well frees cash without hurting sales or supplier relationships.

Receivables. A firm that sells on credit needs a credit policy: who gets credit, how much, on what terms and how overdue accounts are chased. Looser credit can raise sales but increases bad debts and the cash tied up. Tighter credit does the opposite. An aging schedule groups unpaid invoices by how long they are outstanding (for example 0-30, 31-60, 61-90 and over 90 days). If more of the balance moves into older buckets, collection is weakening and bad-debt risk is rising. Analysts also watch days sales outstanding (DSO) and the percentage of sales that go uncollected.

Inventory. Holding stock avoids lost sales but costs money: financing, storage, insurance, obsolescence and shrinkage. Too little stock risks stock-outs. Common methods include just-in-time (JIT), where goods arrive just as needed and inventory stays minimal, and economic order quantity (EOQ), which picks the order size that minimizes total ordering plus holding cost. Inventory is also tracked with days of inventory on hand (DOH) and inventory turnover. Rising DOH can signal slow sales or obsolete stock.

Payables and trade credit. Suppliers often sell on terms such as 2/10 net 30: take a 2% discount if you pay within 10 days, otherwise pay the full amount by day 30. Not taking the discount is like borrowing from the supplier. The discount you give up is the interest. This is usually expensive, so compare the cost of trade credit with the firm's bank borrowing rate. If the cost of trade credit is higher than the cost of other short-term funding, take the discount and borrow if needed. Stretching payables beyond the due date can damage supplier relationships and credit standing.

Key formulas to remember

Cost of trade credit (effective annual rate)
Cost = (1 + discount ÷ (1 − discount))^(365 ÷ (days credit − discount days)) − 1
Use for terms like d/x net y. Days credit = y, discount days = x. This compounds the periodic cost; it is the form the curriculum emphasizes.
Periodic cost of trade credit
Periodic cost = discount ÷ (1 − discount)
Example: 2% discount gives 0.02 ÷ 0.98 = 2.0408%. Always divide by (1 − discount), not by 1.
Number of days you borrow
Extra days = net due day − discount day
For 2/10 net 30 it is 30 − 10 = 20 days. The compounding exponent is 365 ÷ 20.
Days sales outstanding (DSO)
DSO = 365 ÷ receivables turnover = (average receivables ÷ credit sales) × 365
Higher DSO means slower collection.
Days of inventory on hand (DOH)
DOH = 365 ÷ inventory turnover = (average inventory ÷ COGS) × 365
Uses cost of goods sold, not sales.
Days payable outstanding (DPO)
DPO = (average payables ÷ COGS) × 365
Higher DPO means more supplier financing, but beyond terms it creates risk.
Cash conversion cycle
CCC = DSO + DOH − DPO
Shorter is generally better for liquidity.

How to solve Managing Receivables, Inventory and Payables questions

Use this sequence for any question on receivables, inventory or payables.

  1. 1Identify which item the question is about: receivables, inventory or payables.
  2. 2If it asks about credit terms, write the terms as d/x net y and note the discount d, discount period x and due day y.
  3. 3Compute the periodic cost as d ÷ (1 − d), then the days you borrow as y − x.
  4. 4Annualize by raising (1 + periodic cost) to the power of 365 ÷ (y − x) and subtract 1.
  5. 5Compare the result with the firm's alternative financing rate. If trade credit costs more, take the discount; if less, pay late within terms.
  6. 6For ratio questions, pick the right base: credit sales for DSO, COGS for DOH and DPO. Use average balances if given.
  7. 7For qualitative questions, decide whether the action raises or lowers cash tied up, and what risk it adds (bad debts, stock-outs, supplier strain).
  8. 8Check that your answer is one of the three options and that the direction of your conclusion makes sense.

Quickest way: Fast cost of trade credit check

When to use it: Use when a question gives discount terms and asks for the cost or whether to take the discount.

  1. Divide the discount by (1 − discount) to get the periodic cost.
  2. Find borrowing days: due day minus discount day.
  3. Estimate annual cost: periodic cost × (365 ÷ days) for a quick approximation; use compounding if options are close.
  4. Use the calculator: enter 1 + periodic cost, press the yx key (the same key on the TI BA II Plus and the HP 12C) with exponent 365 ÷ days, then subtract 1.
  5. TI BA II Plus: enter 1.020408, press yx, enter 18.25 (365 ÷ 20), press =. Then subtract 1 (− 1 =) to get 0.4459, or 44.6%.
  6. HP 12C: 1.020408 ENTER 18.25 yx, then 1 −.
  7. Compare with the bank rate and choose the cheaper source.

Common mistakes in Managing Receivables, Inventory and Payables

  • Computing the periodic cost as d ÷ 1 instead of d ÷ (1 − d).

    The discount feels like the interest rate, but you only pay the discounted price to get the discount.

    Fix: For 2/10 net 30, the cost is 2 ÷ 98, not 2 ÷ 100. Always divide by the amount you actually pay.

  • Using 30 days (net period) as the borrowing time instead of 20.

    Students read net 30 and use it directly.

    Fix: Borrowing time is the due day minus the discount day. Paying on day 30 instead of day 10 gives you 20 extra days.

  • Forgetting to annualize or compounding wrongly.

    The periodic cost looks small, so it is left as the answer.

    Fix: Raise (1 + periodic cost) to 365 ÷ days and subtract 1. Check that the answer is the annual rate.

  • Using sales instead of COGS in DOH or DPO.

    Mixing up the DSO base with the other ratios.

    Fix: DSO uses credit sales. DOH and DPO use cost of goods sold.

  • Concluding that longer payables are always better.

    A higher DPO shortens the cash conversion cycle.

    Fix: Stretching beyond terms can lose discounts, hurt supplier relationships and damage credit standing. Judge the cost, not just the days.

  • Reading a growing share of old balances in an aging schedule as neutral.

    Total receivables may look stable.

    Fix: Look at the mix. More in older buckets means weaker collection and higher expected bad debts.

Worked examples

Example 1

A supplier offers terms of 2/10 net 30. What is the approximate effective annual cost of not taking the discount (365-day year)? A) 18.6% B) 36.7% C) 44.6%

Show the solution
  1. Periodic cost = 0.02 ÷ 0.98 = 0.020408.
  2. Borrowing days = 30 − 10 = 20.
  3. Exponent = 365 ÷ 20 = 18.25.
  4. Effective annual cost = (1.020408)^18.25 − 1.
  5. ln(1.020408) = 0.020204; × 18.25 = 0.368723.
  6. e^0.368723 = 1.4459, so cost = 44.6%.
  7. Quick check: simple annual cost = 0.020408 × 18.25 = 37.2%, so the compounded figure must be higher, ruling out 18.6% and 36.7%.

Answer: C) about 44.6%

Example 2

A firm buys on 1/15 net 45 terms. Its bank loan costs 12% a year. What is the effective annual cost of forgoing the discount, and which source is cheaper? A) Trade credit costs about 3.4%, so it is cheaper than the bank loan B) Trade credit costs about 12.3%, so the bank loan is cheaper C) Trade credit costs about 13.0%, so the bank loan is cheaper

Show the solution
  1. Periodic cost = 0.01 ÷ 0.99 = 0.010101.
  2. Borrowing days = 45 − 15 = 30.
  3. Exponent = 365 ÷ 30 = 12.1667.
  4. (1.010101)^12.1667: ln(1.010101) = 0.010050; × 12.1667 = 0.122280.
  5. e^0.122280 = 1.1301, so cost of trade credit = 13.0%.
  6. Trade credit at about 13.0% is more expensive than the 12% bank loan, so the bank loan is the cheaper source.
  7. So take the discount, borrow from the bank and pay the supplier on day 15.
  8. Check the options: 3.4% is far too low, and 12.3% understates the compounded cost, so only C matches.

Answer: C) Trade credit costs about 13.0% versus 12% for the bank loan, so the bank loan is cheaper.

Exam tips

  • Questions are standalone with three options. For trade credit, quickly compute d ÷ (1 − d) and the simple annualized cost to eliminate options that are too low.
  • Expect a comparison step: the answer often depends on whether trade credit costs more than the bank rate.
  • Read whether the stem gives credit sales or COGS before computing DSO, DOH or DPO.
  • For qualitative items, think direction: tighter credit lowers receivables and bad debts but may cut sales. JIT lowers inventory cost but raises stock-out risk.
  • Practise the yx keystrokes so a compounded trade credit calculation takes under a minute.

Practice questions from Working Capital and Liquidity

Managing Receivables, Inventory and Payables in other exams

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

Managing Receivables, Inventory and Payables: frequently asked questions

What is the cost of trade credit formula for CFA Level I?

Cost = (1 + d ÷ (1 − d))^(365 ÷ (y − x)) − 1, where d is the discount, x is the discount period and y is the net due day. It gives the effective annual cost of giving up the early payment discount.

Should a company always take the early payment discount?

Not always. Take it when the cost of trade credit is higher than the firm's alternative short-term financing rate. If the cost is lower, paying on the due date is cheaper.

What does an aging schedule show?

It groups unpaid customer invoices by how long they have been outstanding. A rising share in older buckets suggests slower collection and higher bad-debt risk.

How does JIT differ from EOQ?

JIT aims to keep inventory minimal by receiving goods just when needed. EOQ finds the order size that minimizes the sum of ordering and holding costs. JIT depends on reliable suppliers, while EOQ is a cost-minimizing model.