Managing Supplier

Financing
Armand Priyoga Pangestu
Audria Agatha
Bimawan Dwi Kusuma

What is Managing Supplier

Financing?
Apply time value of money principles to the payment of
accounts payable
Decide when the cash flow discount is optimal
Understand ethical issues involved in the payment
decision
Assess payables using the balance fraction approach

Financial Dilemma
Why Pay Early?
The dilemma to use discount in credit terms or pay on
due date
Example 2/5, net 45

Use of Supplier Financing

Supply chain finance is a set of technology-based
business and financing processes that link the various
parties in a transaction the buyer, seller and financing
institution to lower financing costs and improved
business efficiency
Receipt of trade credit from suppliers represents a
spontaneous source of financing, attributable to the
nature of the working capital cycle.
Spontaneous supplier financing = Repay spontaneous
generated liability

Use of Supplier Financing

Open Account, a common credit arrangement between
suppliers and buyers
Net terms, the length of time until payment is due
Discount terms, offering of cash discount for early payment in
credit terms
Seasonal dating, allows retail outlets to purchase inventory
before peak buying season and defer payment until after the
peak season, example: toy manufactures
Consignment, arrangement whereby a retailer obtains an
inventory item without obligation, example: college textbook
industry

Other Type of Spontaneous

Financing
Accruals also provide a spontaneous source of financing
Accruals:
Accrued Wages
Accrued Taxes

Other Types of Credit Terms

Prox Basis, Credit terms on a specific date in the
following month
Example: 2/10, prox net 30

A/P Payment Timing Options

Firms establish an A/P policy based on the
number of days payment is delayed from
the purchase date (DD), choosing from:
1. Date of purchase.

DD = 0

2. On or before end of cash discount period (DP).

DD < DP

3. On or before end of credit period (CP).

DD < CP

4. After credit period ends.

DD > CP
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A/P Payment Timing Options

Say, the terms

offered are 2/10,
net 30:
Firms must
determine when
to pay invoices.
Like before, we
apply TVM
principles to the
payment timing
of A/P, seeking
the lowest NPV.

Purchase
>CP
0 Days
Days

DP
10 Days

CP
30 Days

> 30

1) (DD=0)
2) DD <
DP
3) DD <
CP
4) DD >
CP

A/P Decision Models - NPV

Shown are the variables associated with this decision:

Deciding when to pay

considers these rates:

Cash discount rate (d)

Annualized investment rate (i)

Annualized borrowing rate (ib)

Annualized late payment rate

(fee)

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A/P Decision Models - NPV

There are three

Decision Models based
on the timing of the
delayed payment.

Discount Model

Credit Period
Model

Late Payment
Model
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Payment Decision Model #1

Discount Model - Payment made on or before
the end of the cash discount period (DD < DP):

PV of discounted invoice
price

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Payment Decision Model #2

Credit Period Model - Payment made on or

before the end of the credit period (DD < CP):

PV of full invoice
price

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Payment Decision Model #3

Late Payment Model - Payment made after

the credit period ends (DD > CP):
(IP) [1 +(DD-CP)(fee/365)]
NPV = - ---------------------------------[1 + (DD)(i/365)]
PV of full invoice price plus
late fee

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Payment Decision Model - NPV

While we calculated many possible dates
before, only three need to be calculated:
Last day of discount period.
Last day of credit period.
Some late date after credit period ends.

In general:
A/P should never be paid early.
Pay on the last day of the discount period or the last day
of the credit period.

A/P should not be stretched past the credit period.

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Paying Late
If the late payment penalty fee (fee) is less
than the firm's investment rate (i), the
firm has a financial incentive to pay late.
There are consequences to the firms brand for
paying late:
New orders will not be shipped until the account is
current.
The firms reputation and credit rating can be
comprised.

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Payment Decision Model - NPV

Since late payments should be avoided, it is the
one of the first two models (Discount or Credit
Period) with the lower NPV that is selected.
Choose the smaller of:
[(IP)(1-d)] / [1 + (DD)(i/365)]
IP / [1 + (DD)(i/365)]

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Alternative Decision Model

The reason we would forego the
discount is to retain the funds to
finance operations or to invest shortterm.
The cash discount is not an interest
rate; rather, it is a discount off the
amount of the invoice.
It can be converted to an interest rate,
and then be compared to i and ib.
So, an alternative approach to
calculating NPV is to compare the
Annualized Cash Discount Rate (d).

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Alternative Decision Model

For terms, 2/5, net 45, if we forego the
discount, we pay 2% more for the product.
Said another way, we are paying 2% more
to simply keep our cash for an extra 40
days.
We can convert that to the annualized
equivalent:

k TC

d
(1- d

365

) (CP DP )

Annualized Cash Discount Rate

[The first expression is the effective
discount rate (the discount divided by
the discounted invoice) and the second
expressions annualizes the rate (the
number of times the rate would be

If

the i < kTC, the firm is

better off taking the
discount.

If

the i > kTC, the firm

should keep the cash
and forego the discount.

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Alternative Decision Model

Assuming the firm does not have the cash, but has access to
short-term credit, borrowing the money to take the discount
might make sense if the annualized borrowing rate (ib) is less
than annualized cash discount rate (kTC), given by:

ib < = > kTC = [d / (1 d)] [365 / (CP-DP)]

If the ib < kTC, the firm should borrow to take the discount.
If the ib > kTC, the firm should forego the discount.

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Thank You