Cash Discount Versus Working-Capital Discipline at a Garment Unit
Mridul Das runs a small readymade-garment unit in Guwahati. Annual sales are ₹96 lakh, all on credit, and cost of goods sold is ₹72 lakh. Average balances are inventory ₹12 lakh, trade receivables ₹16 lakh, cash ₹2 lakh, and trade payables ₹9 lakh. Suppliers give 30 days' credit, but Mridul's actual payable period has drifted. Customers currently pay in 61 days on average, although the stated term is 45 days. The unit's bank overdraft costs 12% per annum, and the owner wants to reduce dependence on it. A consultant proposes a cash-discount policy of '2/10, net 45'. She expects 40% of customers to take the discount and pay on day 10; the remaining 60% would pay on day 45. Sales are expected to stay unchanged, and bad debts are negligible. Mridul is tempted but worries that the discount will erode margins: the unit's net profit margin is only 4%. He asks for a quantitative test of the proposal and a judgement on whether to introduce it.
1. Compute the operating cycle and cash conversion cycle. Comment on the gap between the stated supplier credit of 30 days and the actual payable days.
Read the worked answer
Inventory days = ₹12,00,000/₹72,00,000 × 365 = 60.8 days.
Receivable days = ₹16,00,000/₹96,00,000 × 365 = 60.8 days.
Payable days = ₹9,00,000/₹72,00,000 × 365 = 45.6 days.
Operating cycle = 60.8 + 60.8 = 121.7 days.
Cash conversion cycle = 121.7 − 45.6 = 76.0 days.
The stated supplier term is 30 days, so the firm is effectively stretching payables by about 15.6 days. That flatters the CCC and creates a supplier-relations risk; if suppliers tighten terms, the CCC would rise to about 91.7 days.
2. Evaluate the proposed '2/10, net 45' policy: receivables released, interest saved, discount cost, and net benefit.
Read the worked answer
New receivable days = 0.40×10 + 0.60×45 = 4 + 27 = 31 days.
Reduction = 60.8 − 31 = 29.8 days.
Receivables released = ₹96,00,000/365 × 29.8 ≈ ₹7,84,600.
Interest saving at 12% = ₹7,84,600 × 0.12 ≈ ₹94,150.
Discount cost = 2% × 40% × ₹96,00,000 = ₹76,800.
Net benefit ≈ ₹17,350 before any change in bad debts or administration cost.
The proposal is marginally positive. If even a small fraction of the 40% would have paid early without the discount, or if the discount pulls in lower-quality customers, the net benefit disappears.
3. Should Mridul adopt the policy? What conditions or alternative actions would you recommend?
Read the worked answer
Adopt only as a trial, because the net benefit is under 0.02% of sales and Mridul's net margin is only 4%. The discount costs 0.8% of sales, equivalent to 20% of the 4% margin; a forecasting error could wipe out the gain.
Conditions: (i) verify that the 40% response is real; (ii) negotiate supplier terms explicitly rather than stretching payables; (iii) attack inventory days, which are as long as receivable days. A 10-day inventory reduction releases about ₹1.97 lakh (₹72 lakh/365 × 10) and saves about ₹23,600 a year at 12%, with no margin sacrifice. If the discount is introduced, monitor receivables weekly and withdraw it if the response is below 40%.