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For several firms trade payables - suppliers of goods and services - represent the major component of current liabilities the amounts owed by the company which have to be repaid within the next accounting period. Together with inventory and receivables - current liabilities current assets - cash, determine the firm's net working capital position example the net sum it invests in working capital.
Different suppliers will work different credit periods but the average trade credit period in days can be calculated as follows
Trade payables/Credit purchases × 365
Occasionally it is expressed in terms of total purchases and sometimes in terms of overall cost of sales. The length of the trade credit period depends partially on competitive relationships among suppliers and partly on the firm's own working capital policy.
The trade credit period is an significant element in a company's cash conversion cycle - the length of time between a firm making payment for its purchases of materials and labour and receiving payment for its sales. The time period above which net current assets have to be financed depends not only on policy towards suppliers but also on receivables management and inventory control policy
Cash conversion cycle = [Receivables days + inventory period] - [trade credit period]
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At current the working capital cycle is Receivables days $0.4m/$10m * 365 = 15 days Inventory days $0.7m/$8m * 365 = 32 days (cost of sales = $10m - $2m) Payables days $1.
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