Choosing Between Two Supplier Credit Terms
Nabila runs a small Dhaka trading firm with annual sales of ৳90,00,000 and a gross margin of 25%. She currently buys from Supplier A on terms of 2/10, net 45, paying on day 45 because she has no cheaper source of funds. Her bank offers an overdraft at 14% annual interest, and she has ৳4,00,000 of unused overdraft limit. Supplier B offers terms of 1/15, net 60 with a 6% higher list price than A. Nabila's average payables under the current policy are about ৳18,00,000. Her accountant argues that 'any discount is free money' and wants her to take A's discount on every purchase, while her cash manager warns that doing so would strain the overdraft.
1. Compute the annualised cost of forgoing Supplier A's cash discount, and state whether Nabila should borrow at 14% to take it.
Read the worked answer
Cost of forgoing the discount = (d / (1 − d)) × (365 / (N − D)), where d = 0.02, N = 45, D = 10.
= (0.02 / 0.98) × (365 / 35) = 0.020408 × 10.4286 = 0.2128, i.e. about 21.3% per year.
Since 21.3% > 14%, taking the discount by borrowing on the overdraft creates value. On a ৳1,00,000 invoice, paying on day 10 costs ৳98,000 plus about 35 days of interest at 14%: 98,000 × 0.14 × 35/365 ≈ ৳1,316. Total ≈ ৳99,316 versus ৳1,00,000 on day 45. Saving ≈ ৳684 per ৳1,00,000, or roughly 0.68%.
So the accountant is directionally right for Supplier A, but the decision must be checked against the overdraft limit, not asserted as a universal rule.
2. Assess whether Nabila can finance the discount policy within her ৳4,00,000 overdraft headroom, and compare Supplier B's terms.
Read the worked answer
Cost of goods sold = 75% of ৳90,00,000 = ৳67,50,000. Average daily purchases ≈ 67,50,000 / 365 ≈ ৳18,493.
Paying on day 10 instead of day 45 shortens the payment period by 35 days. Extra cash needed ≈ 18,493 × 35 ≈ ৳6,47,000, which exceeds the ৳4,00,000 headroom by about ৳2,47,000. So Nabila cannot take the discount on all purchases; she should take it selectively (perhaps on 60% of volume) or negotiate a higher limit.
Supplier B: cost of forgoing = (0.01/0.99) × (365/45) = 0.010101 × 8.111 = 8.19%, which is below the 14% borrowing rate. Taking B's discount is not worth borrowing for, and B's 6% higher price adds cost: 6% of ৳67,50,000 ≈ ৳4,05,000 per year, far outweighing any discount benefit. Recommendation: stay with A, take the discount up to the overdraft limit, and reject B on price grounds.