A Supplier Discount That Is Almost Worth Taking
Raven Retail buys goods with annual cost of goods sold of ₹135 crore and sells them for ₹180 crore. Inventory is held for 45 days, receivables are collected in 60 days, and payables are paid in 60 days. All purchases and sales are on credit; use a 365-day year. A supplier that accounts for 40% of purchases offers terms of 2/10, net 60. Raven can borrow the extra working-capital requirement at 14% a year on a revolving facility. The CFO estimates that taking the discount would lower the weighted average payable period from 60 days to 40 days and increase the cash conversion cycle. The sales director separately proposes extending credit to a large customer from 60 to 75 days to retain ₹30 crore of annual sales. That customer contributes a 22% contribution margin; the expected bad-debt loss would rise from 0.5% to 2.0% of sales to that customer, and the additional receivables would be financed at 14%. The CFO wants a decision on both proposals, not a textbook rule of thumb.
1. Calculate the cash conversion cycle before and after the supplier discount, and the net annual benefit or cost of taking the discount. Should Raven take it?
Read the worked answer
Current CCC = 45 + 60 − 60 = 45 days. After discount, weighted payable period = 0.4×10 + 0.6×60 = 40 days; CCC = 45 + 60 − 40 = 65 days. Purchases = COGS = ₹135 crore. Discounted supplier purchases = 40% × 135 = ₹54 crore. Discount = 2% × 54 = ₹1.08 crore. Extra financing = 54 × (60 − 10)/365 = ₹7.397 crore; cost at 14% = ₹1.036 crore. Net benefit = ₹0.044 crore, or about ₹4.4 lakh a year. The effective annual cost of not taking the discount is (2/98) × (365/50) = 14.90%, just above the 14% borrowing rate. Taking the discount is marginally better, but the benefit is tiny. Raven should take it only if the facility is available, and should try to negotiate a longer discount period or a lower price; a small improvement in terms would make the decision clear.
2. Evaluate the customer's request. What would change your answer if the customer would stay anyway?
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If the ₹30 crore of sales would be lost without the extension, incremental contribution = 30 × 22% = ₹6.60 crore. Incremental bad debt = (2.0% − 0.5%) × 30 = ₹0.45 crore. Extra receivables = 30 × 15/365 = ₹1.233 crore; financing cost = 14% × 1.233 = ₹0.173 crore. Net benefit = 6.60 − 0.45 − 0.173 = ₹5.977 crore. Accept on these assumptions. If the customer would stay on 60 days anyway, there is no incremental contribution; the extension costs ₹0.45 + ₹0.173 = ₹0.623 crore a year. Then reject. The key judgement is whether the sales are truly at risk. Raven should also check the customer's creditworthiness, because a 2% expected bad-debt rate is high and a single large receivable may create concentration risk.
3. The CFO wants a 30-day cash conversion cycle without taking the discount or changing payables. Calculate two alternative ways to achieve it and the cash released by each relative to current.
Read the worked answer
With payables unchanged at 60 days and CCC of 30 days, inventory days + receivable days = 90. Current sum is 105, so 15 days must be removed. Two pure options:
- Cut inventory from 45 to 30 days: releases 15 × 135/365 = ₹5.55 crore, but raises stock-out and service risk.
- Cut receivables from 60 to 45 days: releases 15 × 180/365 = ₹7.40 crore, but may require tighter credit, discounts or collection pressure and could cost sales. A mix, such as 37.5 inventory days and 52.5 receivable days, releases a weighted amount between these figures. The CFO should choose based on which operating lever is sustainable, not just the cash released.