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Q. Interest rate implied in cash discounts?
Interest rate implied in cash discounts to decide whether you should take benefit of discounts by using your cash or borrowing makes this simple analysis. Suppose that you must pay USD 10000 within 30 days or USD 9800 within 10 days to settle a USD 10000 invoice with terms of 2/10, n/30. By advancing payment 20 days as of the final due date you are able to secure a discount of USD 200.
The interest expense acquires to borrow USD 9800 at 12 percent per year for 20 days is USD 65.33 computed as (USD 9800 x .12 x 20/360). You would save USD 134.67 (USD 200 - USD 65.33) by borrowing the money as well as paying the invoice within the discount period.
In terms of an yearly rate of interest the 2 percent rate of discount for 20 days is equivalent to a 36 percent annual rate (360/20) X 2 percent. The formula is as
You are able to convert all cash discount terms to their approximate annual interest rate equivalents by use of this formula. Therefore a company could afford to pay up to 36 percent [(360/20) X 2 percent] on borrowed funds to take advantage of discount terms of 2/10, n/ 30. The company could compensate 18 percent on terms of 1/10, n/30.
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