You have received an email from a new accounting client, Jamal Parker, who has just started a new business. Jamal would like you to explain whether it is really that beneficial for him to take advantage of a 2/10, net 30 discount offered by one of his

Question

suppliers, given his limited cash flow. In a memo, explain to him why this is or is not a sound financial move for his new company. Most firms attempt to pay their accounts payable within the discount period to take advantage of the discount. Why is that normally a sound financial move?

Answer 1

MEMORANDUM
TO: Jamal Parker
FROM: (student)
DATE: XXX
It is generally beneficial for a company to take advantage of discounts available because of the rate of the discount. In this case, since a 2% discount is available for payment within ten days, a your firm could even borrow money and pay interest on the loan in order to take advantage of the discount. After all, if your supplier is going to give you a 2% discount for paying on Day 10 instead of Day 30, that means you are earning 2% on your money over 20/360 of a year. If you took the 2% discount throughout the year, you would be getting a 36% annual return on your money, since there are 18 periods of 20 days each in a year. Also, prompt payment of accounts is essential in order to ensure good relationships with suppliers and other creditors and will increase your credit rating.