Financial Management and Business Data Analytics · Financing Working Capital

Trade Credit and Cost of Forgoing Cash Discount (2/10 Net 30)

Updated 10 October 2026 · Fact-checked

Trade credit is credit a supplier gives you by letting you pay after delivery. If it offers a cash discount, such as 2/10 net 30, paying late costs you the discount. Cost = [Discount ÷ (100 − Discount)] × [365 ÷ (Credit period − Discount period)]. For 2/10 net 30, this is about 37.2% a year.

Understand Trade Credit and Cost of Credit Terms

Trade credit is the credit a supplier gives when you buy goods and pay later. It is a spontaneous source of short-term finance. It grows as your purchases grow, needs no formal loan agreement and usually has no security.

Suppliers often add a cash discount to encourage early payment. The term 2/10 net 30 means: take a 2% discount if you pay within 10 days; otherwise pay the full invoice amount by day 30. Day 30 is the end of the credit period. Day 10 is the end of the discount period.

Trade credit looks free, but it is not always. If you skip the discount and pay on day 30, you keep the money for 20 extra days (30 − 10). The price of those 20 days is the 2% discount you gave up. That is the cost of forgoing the discount.

The key point is that you do not borrow the full invoice amount. You borrow only the discounted price (100 − 2 = 98 per 100 of invoice). You pay 2 extra for using it for 20 days. So the interest rate for 20 days is 2 ÷ 98. You then scale it up to a year, because the 20 days repeat about 365 ÷ 20 times.

The decision rule is simple. Compare this annual cost with your cost of the next best source, such as a bank cash credit. If the cost of forgoing the discount is higher, take the discount and, if needed, borrow from the bank to pay early. If it is lower, pay on the last day.

Key rules to remember

Cost of forgoing cash discount (simple, annualised): Cost = [d ÷ (100 − d)] × [365 ÷ (N − D)] × 100%; d = discount %, N = credit period in days, D = discount period in days. Use 360 days if the question says so.
Cost of forgoing cash discount (effective, compounded): Effective cost = [1 + d ÷ (100 − d)]^(365 ÷ (N − D)) − 1; Use when the question asks for the effective annual rate or compounding.
Amount actually financed: Funds used = Invoice amount × (100 − d) ÷ 100; This is the cash price if you pay within the discount period.
Decision rule: Take the discount if cost of forgoing > cost of alternative finance; Otherwise pay on the last day of the credit period.
Effect of stretching payment: New cost = [d ÷ (100 − d)] × [365 ÷ (Actual payment day − D)]; Paying after the due date lowers the annual cost, but it may harm the supplier relationship and credit rating.

How to solve Trade Credit and Cost of Credit Terms questions

Use this method for any question on cost of credit terms. Write each step so you earn step marks.

1Read the terms and write d, D and N. For 2/10 net 30: d = 2%, D = 10 days, N = 30 days.
2Find the days of extra credit gained: N − D (or actual payment day − D if the buyer stretches).
3Compute the discount rate on the amount financed: d ÷ (100 − d).
4Annualise using 365 ÷ (N − D), or 360 if the question says so.
5Multiply the two parts and express the result as a percentage. Compute the effective rate too if asked.
6Compare with the cost of bank finance or the return on surplus funds.
7State the decision clearly: take the discount or pay on the due date.
8If rupee amounts are given, also show the saving or loss in rupees for support.

Quickest way: Fast shortcut for 2/10 net 30 type questions

When to use it: Use for MCQs and for checking written answers. Use when the question wants the simple annual cost and not the compounded rate.

Compute d ÷ (100 − d) as a fraction, for example 2 ÷ 98.
Compute 365 ÷ (N − D), for example 365 ÷ 20 = 18.25.
Multiply: 2 ÷ 98 × 18.25 = 0.3724, or 37.2%.
Remember that a bigger discount and a shorter extra period give a higher cost.
For a rough check, a 1% discount with 20 extra days costs a little over 18%; 2% costs a little over 37%.
Compare with the bank rate. If the answer is far above it, take the discount.

Common mistakes in Trade Credit and Cost of Credit Terms

Using d ÷ 100 instead of d ÷ (100 − d).
Students forget that the money actually financed is the discounted price, not the full invoice.
Fix: Always put 100 − d in the denominator. For 2%, divide by 98, not 100.
Using 30 days instead of 20 in the annualising factor.
Students take the whole credit period, not the extra days gained by forgoing the discount.
Fix: Use N − D. The 10 days before the discount deadline are not the extra credit.
Ignoring the days when the buyer pays late.
Students stick to the stated terms even when the question says payment is made on day 45, for example.
Fix: Replace N with the actual payment day. Then the extra days are the actual day − D.
Comparing the cost with the wrong rate, or not comparing at all.
Students stop at the calculation and forget the decision.
Fix: End with a clear sentence that compares the cost with the bank rate or investment return and states the decision.
Mixing simple and effective rates.
The two rates look alike, but the effective rate is higher because of compounding.
Fix: Use the simple formula unless the question says effective or compounded. State which one you used.

Worked examples

Example 1

A supplier offers terms of 2/10 net 30. Calculate the annual cost of forgoing the cash discount (use 365 days) as a simple rate and as an effective rate. Should a firm that can borrow from its bank at 15% take the discount?

Show the solution

d = 2%, D = 10 days, N = 30 days. Extra credit period = 30 − 10 = 20 days.
Rate for the period = 2 ÷ 98 = 0.020408, or 2.0408%.
Annualising factor = 365 ÷ 20 = 18.25.
Simple annual cost = 0.020408 × 18.25 = 0.37245, or about 37.2%.
Effective cost = (1.020408)^18.25 − 1. Since ln(1.020408) ≈ 0.020204, multiplying by 18.25 gives 0.36873. e^0.36873 ≈ 1.4458, so effective cost ≈ 44.6%.
Compare: 37.2% (or 44.6%) is well above the bank rate of 15%.

Answer: Simple cost is about 37.2% a year and effective cost about 44.6% a year. The firm should take the discount, borrowing from the bank at 15% if needed.

Example 2

Navkar Traders buys goods worth ₹5,00,000 on terms 3/15 net 45. It can borrow from a bank at 18% a year. Use 360 days. (a) Find the cost of forgoing the discount. (b) Decide whether to take the discount and find the saving in rupees on the invoice if it borrows to pay on day 15 and repays the loan on day 45.

Show the solution

d = 3%, D = 15 days, N = 45 days. Extra credit period = 30 days.
(a) Cost = 3 ÷ 97 × 360 ÷ 30 = 0.030928 × 12 = 0.37113, or about 37.1%.
The cost of forgoing (37.1%) is higher than the bank rate (18%), so take the discount.
(b) Discount = ₹5,00,000 × 3% = ₹15,000. Amount paid on day 15 = ₹4,85,000.
Borrow ₹4,85,000 for 30 days at 18% on a 360-day basis: interest = 4,85,000 × 18% × 30 ÷ 360 = ₹7,275.
Net saving = ₹15,000 − ₹7,275 = ₹7,725.

Answer: The cost of forgoing the discount is about 37.1% a year. Take the discount, as it is cheaper than the 18% bank loan. The net saving is ₹7,725.

Exam tips

Write d, D and N at the top of your answer. It shows the method and earns step marks.
Check the days basis (360 or 365) and whether the question asks for simple or effective cost.
Look for a late payment day in the question. Use it in place of N when the buyer stretches payment.
Always end with a decision comparing the cost with the alternative source. Many marks go to the conclusion.
In MCQs, check whether the options include the trap answer from using d ÷ 100 or 30 days instead of 20.

Practice questions from Financing Working Capital

Trade Credit and Cost of Credit Terms in other exams

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

Trade Credit and Cost of Credit Terms: frequently asked questions

What does 2/10 net 30 mean?

It means you get a 2% cash discount if you pay within 10 days of the invoice. If you do not, the full amount is due within 30 days.

Why is the denominator 100 − d in the formula?

If you take the discount, you pay 98 on every 100 of invoice. Skipping it means you use that 98 for extra days and pay 2 more. So the rate on funds used is 2 ÷ 98.

Is trade credit really a free source of finance?

It is free only if you pay within the discount period, or if there is no discount. If you pass up a discount, the cost can be very high, as in 2/10 net 30 where it is about 37% a year.

Does paying late reduce the cost of forgoing the discount?

Yes. A longer payment period makes the denominator bigger, so the annual cost falls. But late payment can harm your relationship and credit standing with the supplier.