Working Capital Financing^351
Cash discount terms
In addition to extending credit on net terms, suppliers may offer a cash discount for
payment more prompt than the net terms require. The termsí ì2/10, net 30,î for example,
indicate that the buyer is offered a 2 per cent discount for payment within 10 days of
the date of the invoice. If this discount is not taken, the full amount is due within 30
days. When the buyer is far removed from the seller, or the method of shipping the
goods is slow, terms may be ì2/10, net 30 AOGî. That arrangement affords the buyer
the opportunity of inspecting the goods before paying for them. More important, it
provides all buyers with an equal opportunity to earn the cash discount, regardless of
the transit time required for the goods to reach them.
Rationale for trade credit terms
The variation in trade credit terms described above have a rationale. First; the period of
time for which credit is granted is related to the nature of the commodity sold. High-
style items or perishable merchandise are generally sold on fairly short credit terms
because of the high turnover of the items.
Second, the estimated degree of credit risk is generally reflected in the terms of sale.
Retail shops in the apparel trades are characterised by a rather high rate of failure and
if not failure a exceptionally long credit period (six months on an average), for example.
This may explain the rather large cash discounts usually allowed to such retailers - the
size of the discount reflecting supplierís desires to be paid as quickly as possible.
Third, the nature and extent of competition among suppliers is expressed in credit terms
as well as in prices and service. When a product is new, or if a supplier is soliciting
business from a new account, granting more liberal credit terms than are customary
may be one way of generating additional sales.
Fourth, a supplier short of working capital may offer rather large cash discounts to his
customers to induce them to settle their accounts quickly. In this way, the supplier
reduces his collection period and thus reduces his total working capital requirements. A
thinly capitalised supplier may find that the cost of offering large cash discounts is less
than the cost of borrowing or raising additional equity capital to meet his working capital
needs.
Finally, the financial strength of the supplier relative to that of his customers is also a
determinant of credit terms. Although it might appear that a financially strong supplier
could dictate stringent terms, by doing so he may succeed only in losing some customers
and possibly even putting others out of business.