Accounts payable, trade credit

Accounts payable are a part of a firm’s current liabilities, debts that must be paid within the short term. The accounts payable are the firm’s trade credit. As the firm does business with its suppliers and other firms on a credit basis, accounts payable accrue. Trade credit is a source of CAPITAL for the firm. Using invoices instead of cash, trade credit facilities purchases from suppliers and others; cumbersome cash transactions aren’t necessary when firms have good trade credit. When the accounts payable are kept current (i.e., paid on a timely basis), trade credit creates a good reputa¬tion for the firm among those with whom it does business.

To encourage the early payment of invoices, most sup-pliers’ invoices contain sales discounts. There are percentages that can be deducted for the early payment of an invoice. A commonly used sales discount found on invoices is “2/10, net 30.” This means that 2 percent may be deducted from the invoice if payment is made within 10 days of the invoice date; otherwise the full amount of the invoice is due within 30 days of the invoice date.

Sales discounts apply to short periods of time, usually 10 or 15 days, but when expressed as an annual percent¬age rate, these discounts are considerable and are powerful incentives for credit customers to pay early. The sales dis¬count of “2/10, net 30” is greater than 36 percent when expressed as an annual percentage rate; “1/15, net 30” is approximately a 24-percent annual percentage rate. Con¬sider a firm with a sizable amount of trade credit, which consistently pays its bills late, not taking advantage of the sales discounts. Such a firm is using its suppliers’ money,

borrowing it at INTEREST RATES more commonly associated with CREDIT CARDs and finance companies.