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Chapter 8: Problem 9

Explain why most business firms pay their accounts payable within the discount period. As a manager, in what circumstance might you decide to pay after the discount period has expired?

Short Answer

Expert verified
Firms usually pay their accounts payable within the discount period to take advantage of discounts offered by suppliers and to reduce their costs. However, in rare cases such as cash shortfall or when higher returns can be made on the payable elsewhere, a manager might decide to pay after the discount period.

Step by step solution

01

Understanding the concept of Accounts Payable

Accounts payable are the short-term financial obligations or debt of a company owes to its suppliers or vendors. They arise when a firm purchases goods or services on credit and promises to make the payment within a specific time period.
02

Reason for paying within the Discount Period

Most businesses opt to pay their accounts payable within the discount period primarily to take advantage of the early settlement discounts offered by suppliers. These discounts, often a certain percentage of the total invoiced amount, serve as an incentive for businesses to pay their debts earlier rather than later. By doing so, businesses can reduce their overall expenses and enhance their profitability.
03

Exception to Paying within the Discount Period

However, there might be instances when a business, under the directive of a manager, decides to pay after the discount period has lapsed. This might happen when the business is facing a cash crunch and needs to manage its available cash to ensure survival and continuity. Another plausible situation might be when the firm can earn an outside return on the payable that is greater than the discount offered by the supplier. In such cases, a late payment - despite the lost discount - can be a more financially viable decision.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Discount Period
A discount period is a specific time frame offered by suppliers during which businesses can make early payments to receive discounts on their invoices. Typically, suppliers provide this incentive to encourage prompt payments. The discount is a percentage deduction from the total amount owed. Paying within this period helps businesses manage their costs effectively and improve profitability.
For example, if a supplier offers a "2/10 net 30" discount, it means the business can take a 2% discount if they pay within 10 days, instead of paying the full amount in 30 days.
In essence, a discount period not only fosters positive relations with suppliers but also contributes to effective financial management.
Financial Management
Financial management involves planning, organizing, directing, and controlling financial activities within a company. It is crucial for ensuring that a company meets its financial obligations and utilizes its resources efficiently.
Key aspects include:
  • Strategic planning for future financial needs
  • Managing cash flows effectively
  • Ensuring liquidity to meet short-term obligations

Effective financial management helps businesses choose when to take advantage of early payment discounts and when to conserve cash for other investments. A well-crafted financial strategy ensures that the company remains solvent while maximizing profitability.
Cash Flow Management
Cash flow management refers to the process of monitoring, analyzing, and optimizing the cash inflows and outflows of a business. Maintaining positive cash flow is essential for day-to-day operations and long-term growth.
Important aspects include:
  • Regularly reviewing cash flow statements
  • Setting appropriate payment and collection policies
  • Managing creditor and debtor relationships

Businesses must balance paying accounts payable within the discount period against other cash needs. Sometimes, retaining cash for other vital operational needs might take precedence over securing a discount, especially if the company faces a cash crunch.
Supplier Discounts
Supplier discounts are financial incentives given by suppliers to encourage early payment of invoices. These discounts are beneficial for both the supplier, who improves their cash flow, and the buyer, who can decrease expenses.
Types of supplier discounts often include:
  • Percentage discounts for early payment (e.g., "2/10 net 30")
  • Bulk purchase discounts
  • Loyalty discounts for regular customers

The decision to avail of supplier discounts can significantly impact a company's cash flow and profitability. Managers must weigh the benefits of these discounts against other financial priorities to make informed payment decisions.

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Most popular questions from this chapter

Use the accounting equation to show the effects of each of the following transactions on the firm's balance sheet: 1\. Borrowed \(\$ 20,000\) cash from First Bank and signed an interest-bearing \(120-\) day note \((12 \% \text { annual interest rate })\) on October 1. 2\. On November 1 , borrowed cash from Interwest Bank. Signed a note with a face value of \(\$ 18,000\) and a maturity of 90 days. The bank discounted the note at a \(10 \%\) annual interest rate and issued the net proceeds to the firm. 3\. At December 31 (year-end), record the following adjustments: \(\cdot\)Accrued interest on the note in transaction 1 \(\cdot\)Interest incurred on the note in transaction 2. 4\. Paid the note in transaction 1 plus interest at maturity. 5\. Paid the note in transaction 2 at maturity.

Set up column headings as necessary (including a Warranty Payable column) and use the accounting equation to record the effects of each of the following transactions on the firm's balance sheet: 1\. Accrued warranties estimated at \(\$ 1,200,000\) on December 31,2000 . (Set up a Warranty Payable column.) 2\. Paid warranty claims costing \(\$ 1,300,000\) in cash during 2001 3\. Borrowed \(\$ 10,000,000\) at \(9 \%\) annual interest for 240 days on September 30 \(2001 .\) Assume 360 days in a year. 4\. Sold goods costing \(\$ 12,000,000\) for \(\$ 25,000,000\) cash during 2001. 5\. Accrued interest on the loan on December 31,2001 . (Set up an interest payable column in your worksheet.) 6\. Management estimated that the warranties obligation at December 31,2001 (based on past sales and warranty claims) should be \(\$ 1,500,000\). Why was there a negative balance in the Warranty Payable column before your adjustment? 7\. Repaid the loan, plus interest at the maturity date.

Explain your agreement or disagreement with the inclusion of the following items among a firm's current liabilities: a. Estimated future expenditures to provide warranty repairs on items sold prior to the balance sheet date. b. Estimated future expenditures for legal costs to be incurred in defending the firm from product liability suits filed before the balance sheet date. c. Accrued restructuring costs due to a plant closure. d. Contingent liability resulting from environmental damages caused by illegal dumping of hazardous waste materials.

Use a balance sheet equation to analyze the effects of the following transactions on Jack's Shoe Company: 1\. Jack's Shoe Company acquired 300 pairs of shoes and is billed \(\$ 18,000 .\) Jack's has not yet paid for the shoes. 2\. Jack's Shoe Company made a partial payment of \(\$ 6,000\). 3\. Jack's Shoe Company returned 10 pairs of shoes with a note requesting a credit of \(\$ 610\) to its account. 4\. Jack's paid the balance due on its account. 5\. Assume that Jack's Shoe Company is offered a \(10 \%\) discount for prompt payment of all due amounts. Jack's intends to take advantage of all discounts, and all payments are made within the discount period. Show how the previous transactions would be recorded, using the balance sheet equation and assuming that the \(10 \%\) discount is properly taken at the end of the appropriate discount period.

In its first year, Sam's Subway Emporium engaged in the following transactions. Indicate the effects of each transaction on Sam's balance sheet by using the balance sheet equation. Total your worksheet at the end of the first year and prepare a simple balance sheet. 1\. Sam's was formed with a cash investment of \(\$ 50,000\) in exchange for common stock. 2\. Sam's purchased a lunch cart for \(\$ 10,000\) cash. 3\. Sam's ordered food and other supplies at a cost of \(\$ 13,500,\) not yet received. 4\. Sam's received the food and supplies, but intended to pay later. 5\. Sam's felt quite generous and gave its employees an advance on their first week's wages of \(\$ 2,500\). 6\. Sam's then got a bit nervous about whether it could pay its employees and suppliers in subsequent months, so a bank loan of \(\$ 100,000\) was acquired at an annual interest rate of \(10 \%\). 7\. Sam's failed to pay for its first month's food and other supplies; the supplier billed Sam's a \(20 \%\) late fee. 8\. Sam's paid the employee's salaries of \(\$ 67,500\) during the year and also recognized the wages that were paid in advance as expenses. 9\. Assume that an entire year has passed and Sam's has made no payments on the loan or the supplier's bill. The late fee is assessed quarterly (four times each year) if the account is not paid. Accrue interest on the loan and use an interest payable account for both the late fees and the interest on the loan. 10\. On the first day of the next year, will Sam's be able to repay the loan? If so, show the effects of the loan repayment.
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