Financial Management and Business Data Analytics · Payable Management

Cash Discount Decision and Cost of Foregoing Discount

Updated 10 October 2026 · Fact-checked

A cash discount is a price cut for paying early. Its cost of foregoing is the annualised rate you pay by skipping it: [d ÷ (100 − d)] × [365 ÷ (credit period − discount period)]. If this rate is higher than your cost of borrowing, take the discount and finance the payment.

Understand Cash Discount Decision and Cost of Foregoing Discount

Suppliers often sell on credit but offer a discount for early payment. A term like 2/10 net 45 means: deduct 2% if you pay within 10 days, otherwise pay the full amount by day 45.

Skipping the discount is not free. By paying on day 45 instead of day 10, you use the supplier's money for 35 extra days. The price of that use is the discount you give up. On an invoice of ₹100, you pay ₹98 on day 10 or ₹100 on day 45. So you pay ₹2 to borrow ₹98 for 35 days.

This ₹2 on ₹98 for 35 days looks small. Annualised, it is large, because a year has many 35-day periods. That annual rate is the cost of foregoing the discount. It is an implicit interest rate on trade credit.

The decision is a comparison. If the cost of foregoing is higher than what it costs you to raise funds elsewhere (bank loan, cash credit, return on surplus cash), pay early and take the discount. If it is lower, forgo the discount and pay on the last day. Always pay on the last allowed day if you forgo the discount. Paying midway gets you neither benefit.

Stretching payment beyond the credit period lowers the annualised cost because the denominator grows. But it may bring penalties, a damaged supplier relationship or a poor credit rating. Exams usually say whether stretching is allowed.

Key rules to remember

Cost of foregoing discount (simple, annualised): [d ÷ (100 − d)] × [365 ÷ (N − D)]; d = discount %, N = credit period in days, D = discount period in days. Use 360 days if the question says so.
Cost of foregoing discount (compound, effective): [1 ÷ (1 − d)]^(365 ÷ (N − D)) − 1; d as a decimal. Use it only when the question asks for the effective or compounded rate.
Amount paid if discount is taken: Invoice value × (1 − d); This is the amount you need to arrange (or borrow) on day D.
Net benefit of taking discount with borrowing: Discount amount − Interest on (invoice − discount) for (N − D) days; Interest = Amount borrowed × bank rate × (N − D) ÷ 365. A positive result means take the discount.
Decision rule: Cost of foregoing > Cost of funds → take discount; otherwise forgo and pay on day N; Compare like with like: both rates annual, both on the same day basis.

How to solve Cash Discount Decision and Cost of Foregoing Discount questions

Use this sequence for any cash discount versus credit period question.

1Read the terms and write d, D and N. For 3/15 net 60, d = 3%, D = 15 days, N = 60 days.
2Note the day basis (365 or 360) and any stretch period the question allows.
3Compute the days gained by forgoing: N − D (or the stretched date minus D).
4Compute the annualised cost: [d ÷ (100 − d)] × [days basis ÷ days gained]. Convert to a percentage.
5Find the alternative cost of funds: bank interest rate, or return on surplus cash if the firm has idle funds.
6Compare. If the cost of foregoing is higher, take the discount and borrow if needed. If lower, forgo and pay on the last day.
7Where asked, support the decision with rupee figures: discount saved against interest paid. State the decision in one clear sentence.

Quickest way: Rate-first shortcut

When to use it: Use this for MCQs and for the first part of written answers where only the decision is needed.

Write d ÷ (100 − d) as a fraction, such as 2/98 or 3/97. Do not use d ÷ 100.
Work out days basis ÷ (N − D), for example 365 ÷ 35 ≈ 10.43.
Multiply the two to get the annual rate. Round to two decimals.
Compare directly with the bank rate. Higher cost of foregoing means take the discount.
In MCQs, eliminate options that use d ÷ 100 or N instead of N − D. These are the usual wrong options.

Common mistakes in Cash Discount Decision and Cost of Foregoing Discount

Using d ÷ 100 instead of d ÷ (100 − d).
Students treat the discount as a percentage of the invoice. But the amount actually used as credit is the invoice minus the discount.
Fix: Always write the fraction as 2/98, 3/97 and so on. The base is what you pay on the discount date.
Using the full credit period N in the annualising factor.
The 'net 45' number stands out, so students use 365 ÷ 45.
Fix: The extra credit starts after the discount period. Use N − D, here 45 − 10 = 35 days.
Comparing a rate with the discount percentage itself.
2% looks small against a 15% bank rate, so students conclude the discount is not worth it.
Fix: Annualise first. A 2% discount for 35 days is about 21% a year.
Borrowing for the wrong number of days in the rupee comparison.
Students compute interest for the whole credit period or a full year.
Fix: The bank loan is needed only from day D to day N, so interest is for N − D days on the amount paid.
Paying on a day between D and N when forgoing the discount.
Students think paying a little earlier is safer.
Fix: If the discount is lost, pay on the last allowed day. Early payment then gives no benefit and uses your funds longer.
Mixing 360 and 365 days, or comparing a compound rate with a simple rate.
Formula versions are remembered loosely.
Fix: Use the day basis given in the question and the same method for both rates. Default to the simple formula with 365 days unless told otherwise.

Worked examples

Example 1

Varun Traders buys goods worth ₹10,00,000 on terms 2/10 net 45. The company can borrow from its bank at 15% per annum. Use 365 days. Should it take the discount? Show the rupee benefit.

Show the solution

d = 2%, D = 10 days, N = 45 days. Days gained by forgoing = 45 − 10 = 35.
Cost of foregoing = (2 ÷ 98) × (365 ÷ 35) = 0.020408 × 10.4286 = 0.2128, or 21.28%.
Bank rate is 15%. Since 21.28% > 15%, taking the discount is cheaper.
Rupee check: discount = 2% of ₹10,00,000 = ₹20,000. Amount paid on day 10 = ₹9,80,000.
Interest on ₹9,80,000 for 35 days at 15% = 9,80,000 × 0.15 × 35 ÷ 365 = ₹14,095.89 (approx).
Net benefit = ₹20,000 − ₹14,096 = ₹5,904 (approx).

Answer: Take the discount and borrow ₹9,80,000 from the bank for 35 days. The cost of foregoing is 21.28% against a 15% borrowing cost, giving a net saving of about ₹5,904.

Example 2

Kaveri Industries is offered terms 3/15 net 60. Its bank charges 18% per annum. The supplier is known to tolerate payment up to day 90 without penalty. Use 365 days. Compare the options and advise.

Show the solution

d = 3%, D = 15 days. Factor d ÷ (100 − d) = 3 ÷ 97 = 0.030928.
Option 1: forgo the discount and pay on day 60. Days gained = 60 − 15 = 45. Cost = 0.030928 × (365 ÷ 45) = 0.030928 × 8.1111 = 0.2509, or 25.09%.
Option 2: forgo the discount and pay on day 90. Days gained = 90 − 15 = 75. Cost = 0.030928 × (365 ÷ 75) = 0.030928 × 4.8667 = 0.1505, or 15.05%.
Option 3: take the discount and borrow at 18%.
Compare: paying on day 60 costs 25.09%, which is above 18%. So it is worse than borrowing.
Paying on day 90 costs 15.05%, which is below 18%. So it is cheaper than borrowing, provided the stretch really is penalty-free.

Answer: If stretching to day 90 is truly free of penalty, forgo the discount and pay on day 90 (15.05% < 18%). If the firm must pay by day 60, take the discount and borrow at 18%, since forgoing would cost 25.09%.

Exam tips

Show the formula with the numbers substituted. Step marks go to the setup even if the arithmetic slips.
Always end with a one-line decision that names both rates, for example '21.28% > 15%, so take the discount'.
Check whether the question gives 360 or 365 days, and whether it asks for simple or effective cost. Follow it exactly.
Watch for twists: a stretched payment date, surplus cash earning a return, or a tax rate on interest. Treat these as the alternative cost of funds.
In MCQs, test the options quickly: wrong choices usually come from using d ÷ 100 or N instead of N − D.

Practice questions from Payable Management

Cash Discount Decision and Cost of Foregoing Discount in other exams

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

Cash Discount Decision and Cost of Foregoing Discount: frequently asked questions

What does 2/10 net 30 mean?

It means you get a 2% discount if you pay within 10 days. Otherwise the full amount is due on day 30. Here the discount is lost by paying 20 days later, so N − D = 20.

Should a company take the cash discount or borrow from the bank?

Compare the annualised cost of foregoing the discount with the bank's interest rate. If the cost of foregoing is higher, take the discount and borrow to pay early. If the bank rate is higher, forgo the discount and pay on the last day.

Which day basis should I use, 360 or 365?

Use whatever the question states. If nothing is stated, 365 days is the safer default. Use the same basis throughout and say so in your answer.

Why is the cost of foregoing discount so high?

The discount is earned for paying only a few weeks early, but the rate is stated per year. A small percentage repeated many times a year gives a large annual rate. That is why trade credit without discount can be an expensive source of finance.