Case Scenario:
You work for a company that extends trade credit to customers. Currently your variable cost ratio is 65% and the annual rate of interest set by the company is 4% and the terms are a 30-day net. It costs you $0.07 on the dollar for administrative costs.
Your monthly credit extension is $400,000 and you know (based on previous calculations) that 30% of your customers pay within 30 days, 30% pay within the 60-day net period, 25% pay within a 90-day period and the last 15% pay in a 120-day period. Calculate NVP of the extended trade credit.
Next, calculate the average collection period. If the current industry standard collection period is 40 days, determine if an early payment credit is worth implementing. How great of a discount should you provide?
Finally, what other factors would you consider when implementing an early payment discount? Why?