Transcript Learning Objectives

Chapter 7
Managing Payable and Accruals
Order
Placed
Order
Received
< Inventory >
Sale
Payment Sent Cash
Received
Accounts
Collection
< Receivable > < Float >
Time ==>
Accounts
< Payable >
Invoice Received
Disbursement
<
Float
>
Payment Sent
Cash Disbursed
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Learning Objectives
Apply time value of money principles to the
payment of accounts payable.
 Decide when to take a cash discount for early
payment and when to pay at the end of the credit
period.
 Better understand the ethical issues involved in
payables behavior.
 Develop appreciation for role information systems
play in managing payables.
 To develop effective monitoring tools.

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Spontaneous Sources of Financing

Definition
– a financing source occurring spontaneously from operations

Examples
– payables
– accruals
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Accounts Payable
Open account
 Cash discount
 Prox
 Seasonal dating
 Consignment

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Payables Decisions and the Cash
Flow Timeline
Time ==>
Purchase
Date
Cash
Discount Date
Credit
Period
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Basic Principles

Never pay early, pay on the last day of:
– the discount period, or
– the credit period

Take a cash discount when:
– implied interest rate > opportunity rate

Stretch only as a last resort, not as a policy – notify
creditor before doing so, attempt to negotiate
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Payment Decision Model

When days delayed < discount period

When days delayed > discount period

When days delayed > credit period
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When Days Delayed < Discount
Period

NPV = IP x (1-d) / (1 + (DD(k/365)))
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When Days Delayed > Discount
Period

NPV = IP / (1 + (DD(k/365)))
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When Days Delayed > Credit Period

IP x (1 +(DD-CP)x(f/365))
NPV = ---------------------------------(1 + (DD(k/365)))
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Take or Leave a Discount

IP x (1-d) < IP / (1 + (CP-DP)x(k/365))

k < (d/(1-d)) x (365/(CP-DP))
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Ethics and the Payment Decision
Top Tier: Make a commitment of the will to enhance the
well-being of our neighbors
Middle Tier: The “Sunlight” test: Would both interested &
impartial observers find my decision to be prudent & sound?
Lower Tier: Does the decision obey the intent and letter
of the law?
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Monitoring the Payables Balance

Payables turnover approach
– Period purchases / Accounts payable

Days purchases outstanding
– Accounts payable / Average daily purchases

Balance fraction approach
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Accruals

Definition
– an expense that has been incurred but has not yet been paid

Two basic types
– accrued wages and salaries
– accrued interest and taxes
Copyright  2005 by Thomson Learning, Inc.
Summary
A cash discount should be taken when the
investment/borrowing rate is less than the
annualized discount rate.
 Otherwise, pay at the end of the credit period.
 Payment should not be stretched past the credit
period.
 The balance fraction monitoring method is
preferred over the payables turnover method since
turnover is influenced by purchasing trends.

Copyright  2005 by Thomson Learning, Inc.