636 PART 5 Short-Term Financial Decisions
spontaneous liabilities
Financing that arises from the
normal course of business; the
two major short-term sources of
such liabilities are accounts
payable and accruals.
unsecured short-term financing
Short-term financing obtained
without pledging specific assets
as collateral.
accounts payable management
Management by the firm of the
time that elapses between its
purchase of raw materials and its
mailing payment to the supplier.
Hint An account payable of
a purchaser is an account
receivable on the supplier’s
books. Chapter 14 highlighted
the key strategies and
considerations involved in
extending credit to customers.
LG1 LG2 15.1 Spontaneous Liabilities
Spontaneous liabilitiesarise from the normal course of business. The two major
spontaneous sources of short-term financing are accounts payable and accruals.
As the firm’s sales increase, accounts payable increase in response to the
increased purchases necessary to produce at higher levels. Also in response to
increasing sales, the firm’s accruals increase as wages and taxes rise because of
greater labor requirements and the increased taxes on the firm’s increased earn-
ings. There is normally no explicit cost attached to either of these current liabili-
ties, although they do have certain implicit costs. In addition, both are forms of
unsecured short-term financing—short-term financing obtained without pledging
specific assets as collateral. The firm should take advantage of these “interest-
free” sources of unsecured short-term financing whenever possible.Accounts Payable Management
Accounts payable are the major source of unsecured short-term financing for
business firms. They result from transactions in which merchandise is purchased
but no formal note is signed to show the purchaser’s liability to the seller. The
purchaser in effect agrees to pay the supplier the amount required in accordance
with credit terms normally stated on the supplier’s invoice. The discussion of
accounts payable here is presented from the viewpoint of the purchaser.Role in the Cash Conversion Cycle
The average payment period is the final component of the cash conversion cycle
introduced in Chapter 14. The average payment period has two parts: (1) the
time from the purchase of raw materials until the firm mails the payment and (2)
payment float time (the time it takes after the firm mails its payment until the
supplier has withdrawn spendable funds from the firm’s account). In the preced-
ing chapter, we discussed issues related to payment float time. Here we discuss
the management by the firm of the time that elapses between its purchase of raw
materials and its mailing payment to the supplier. This activity is accounts
payable management.
The firm’s goal is to pay as slowly as possible without damaging its credit
rating. This means that accounts should be paid on the last day possible, given
the supplier’s stated credit terms. For example, if the terms are net 30, then the
account should be paid 30 days from the beginning of the credit period,which is
typically either the date of invoiceor the end of the month(EOM) in which the
purchase was made. This allows for the maximum use of an interest-free loan
from the supplier and will not damage the firm’s credit rating (because the
account is paid within the stated credit terms).EXAMPLE In the demonstration of the cash conversion cycle in Chapter 14 (see
pages 601–602), MAX Company had an average payment period of 35 days
(consisting of 30 days until payment was mailed and 5 days of payment float),