Question

You are the payables accountant for a medium sized electrical contracting company. You are paying bills with purchase discounts but can't take advantage of them because the cash balance in the checking account is low. You approached your boss with a suggestion that the company borrow money at the bank so you can pay the bills in time to take the discounts. Your boss thinks you are a little crazy to recommend borrowing from the bank (currently charging 6% interest) to take advantage of 1-2% discounts.

Write him a memorandum laying out your suggestion and justifying your suggested course of action.

Respond to two other student's posts.

Use actual numbers in your memo. For example, if you need to borrow money to pay a $10,000 bill that offers terms of 2/10, n/30 and the loan's interest rate is 6%.

Answer 1

BANK LOAN Vs CASH DISCOUNTS.
The discount term of 2/10, n/30, will effectively work to much more
than the bank interest of 6%, if the effective rate is calculated.
The discount of 2%, is for 20 days (30 days -10 days) and is for
not paying 98% of the dues on the 10th day. Hence, the interest
rate for 20 days = 2/98 = 2.04%. If this is converted to the effective
interest rate (assuming compounding every 20 days) it will be = (1+2/98)^(365/20)-1 =	44.59%
Hence, it would be very advantageous to borrow and pay by the 10th day, so that
the effective discount of 44.59% can be availed by taking the bank loan at 6%