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

Under the trade credit terms '2/10, net 30', a buyer decides to forgo the cash discount and pays on the 30th day. Which description best fits the position?

The buyer gets 20 extra days of credit, from day 10 to day 30, but at an implicit financing cost equal to the 2% discount given up. Credit taken after the discount period is therefore never free, even when no interest is charged explicitly.

  1. AThe buyer enjoys 20 extra days of credit at an implicit cost of financingCorrect
  2. BThe buyer earns a return of 2% for paying late
  3. CThe buyer gets free credit for 30 days with no cost
  4. DThe buyer's payables period reduces to 10 days

Explanation

Forgoing the discount means paying the full invoice on day 30 instead of the discounted amount on day 10. The 20 extra days of credit are not free, because the discount lost is the implicit financing cost. Calling it free credit ignores that lost discount.

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