Creditors/Payables Management

Managing creditors / payables is a key part of working capital management.

Trade credit is the simplest and most important source of short-term finance for many companies. The objectives of payables management is to ascertain the optimum level of trade credit to accept from suppliers.

Deciding on the level of credit to accept is a balancing act between liquidity and profitability.

By delaying payment to suppliers companies face possible problems:

• supplier may refuse to supply in future
• supplier may only supply on a cash basis
• there may be loss of reputation
• supplier may increase price in future.

Early settlement discounts

A proportion of the firm's suppliers will normally offer early settlement discounts which should be taken up where possible by ensuring prompt payment within the specified terms where settlement discount is allowed. However, if the firm is short of funds, it might wish to make maximum use of the credit period allowed by suppliers regardless of the settlement discounts offered.

Annual cost of a discount

The calculation of the annual cost of a discount can be expressed as a formula:

Notice that the annual cost calculation is always based on the amount left to pay, i.e. the amount net of discount.

If the annual cost of the discount exceeds the rate of overdraft interest then the discount should not be accepted 

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Tags:	early settlement discount;payables management;creditors;payables;discounts