## Management of Payables (Creditors)

### Why Payables Management Matters

Classic business wisdom: "If you can buy well, you can sell well."
Managing creditors and suppliers is as important as managing debtors.
Trade creditors are a spontaneous / short-term source of finance — they arise naturally from ordinary business transactions (no formal negotiation needed).
Paying too slowly creates ill-feeling, disrupts supplies, and damages the firm's image.
Payables are a vital tool for effective cash management.

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## Costs and Benefits of Trade Credit

### A. Cost of AVAILING Trade Credit

(Trade credit is not truly free — it carries implicit costs)

Cost	Explanation
Price (Discount Lost)	Paying on credit means forgoing the early-payment discount — this implicit cost can be very high
Loss of Goodwill	Overstepping credit terms → supplier may deprioritize or discriminate against the firm
Administrative Cost	Managing creditors involves accounting, reconciliation, and follow-up overhead
Conditions	Supplier may impose minimum order quantities or regularity as a condition for extending credit

Implicit Annual Cost of Foregoing a Discount:

$$\text{Effective Annual Cost} = \frac{d}{100 - d} \times \frac{365}{N}$$

Where: d = discount %, N = extra days of credit obtained by not paying early.

### B. Cost of NOT TAKING Trade Credit

(Paying early before credit period is also costly)

Cost	Explanation
Inflation Impact	In inflationary times, borrowers benefit from paying later — same nominal amount = lower real value
Interest Cost	Trade credit is effectively an interest-free loan; not using it forces the firm to borrow at market rates
Inconvenience to Supplier	The supplier may have planned their own cash flows around receiving deferred payment

### The Optimal Decision

The firm must compare:

Implicit cost of availing credit (discount foregone) vs.
Explicit cost of borrowing (to pay early and take the discount)

If borrowing rate < implicit cost of trade credit → Borrow and pay early (take the discount).

If borrowing rate > implicit cost of trade credit → Use trade credit (delay payment).

Worked example

### Example 1

Implicit Cost of Trade Credit (Discount Foregone):

Supplier terms: 2/10, net 30

(2% discount if paid within 10 days; otherwise full amount due within 30 days)

If the firm does NOT avail the discount and pays on day 30:

$$\text{Effective Annual Cost} = \frac{2}{100 - 2} \times \frac{365}{30 - 10} = \frac{2}{98} \times \frac{365}{20} = 0.02041 \times 18.25 = 37.24\% \text{ p.a.}$$

Interpretation: Not taking the 2% discount is equivalent to paying 37.24% per annum for the extra 20 days of credit.

Decision:

If the firm can borrow from a bank at 12% p.a. → Borrow and pay within 10 days to avail the discount.
If borrowing costs 40% p.a. → Use trade credit (cheaper to forgo the discount).

⚠️ Common exam mistakes

Trade credit is NOT free — the discount foregone can represent an extremely high implicit interest rate (often 30–40%+ p.a.)
In inflationary environments, delaying payment favors the firm (borrower) — this is a benefit of availing trade credit
Goodwill loss from late payment is qualitative but can be severe — suppliers may reduce credit limits, require advance payment, or give priority to other customers
The implicit cost formula: use (d / (100−d)) not just (d/100) — the denominator adjusts for the fact that you pay on the net amount
Extra days N = (credit period) − (discount period) — e.g., for 2/10 net 30, N = 30 − 10 = 20 days

Reference:

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Management of Payables — Introduction and Costs of Trade Credit

Worked example

⚠️ Common exam mistakes