Chapter 13 • Management of working capital
Restrictions
Many suppliers insist that, to be granted credit, orders must be of some minimum size
and/or regularity.Exchange rate costs
Businesses that buy on credit where settlement is to be in an overseas currency are
exposed to risk and potential cost. Normally, buyers expect to be invoiced in their
home currency, which means that the customer does not face this problem, but there
are exceptions to this. This will be discussed at some length in Chapter 15.The costs and risks of not taking credit
The costs and risks of not taking credit are set out below.Financing cost
Trade credit is, in effect, interest-free borrowing, so failure to exploit it has a financing
cost. It may be worth incurring some of the costs of taking credit, particularly when
financing costs are high. With Associated British Foods plc, the financing cost saving
in 2007 from exploiting free trade credit offered by suppliers was £49 million, an
amount equal to about 9 per cent of the business’s operating profit for that year. Had
the business not taken advantage of this, the shareholders would be poorer by £49 mil-
lion. See page 355 for an explanation of how the cost of financing ABF’s working cap-
ital is derived.Inflation
In periods of inflation, borrowers are favoured over lenders with the levels of interest
rates not seeming totally to redress the balance.Inconvenience
It may be inconvenient, for the reasons discussed in the context of trade receivables, to
pay at the time of delivery of the goods or performance of the service. It will probably
also inconvenience the supplier. Indeed, insistence on paying on delivery may even be
a cause of loss of supplier goodwill. If the supplier’s systems are geared to deferred
payment, a customer who insists on immediate settlement may not be welcome.Some practical points in the management of trade payables
Establish a policy
After weighing the two types of cost, a policy should be established and followed. It
may well be that suppliers are treated differently according to
l the discounts offered for prompt payment;
l the attitude to credit taken by individual suppliers; and/or
l the weight of any possible repercussions arising from loss of supplier goodwill.Exploit trade credit as far as is reasonable
For the typical business it is unlikely that the costs of claiming credit outweigh the con-
siderable advantage of doing so.