Lesson 2 of 7 · All lessons in this module
- The operating cycle and the cash conversion cycleVideo lesson
- Shortening the cycle and the cost of trade creditVideo lesson
- Total and net working capital
- Liquidity and its primary and secondary sources
- Drags, pulls and liquidity ratiosVideo lesson
- Conservative, moderate and aggressive working capitalVideo lesson
- Short-term funding strategy
Lesson 2 of 7 · 13 min
Shortening the cycle and the cost of trade credit
Firms shorten the cash conversion cycle by cutting inventory days, collecting faster and paying later, but paying later can mean giving up a supplier discount that is a very expensive form of borrowing.
In short
- Cut DOH: drop slow-selling products, get more frequent (just-in-time) deliveries, forecast demand better.
- Cut DSO: prompt-payment discounts, late fees, tighter credit standards, deposits or faster instalments, collection agencies.
- Raise DPO: negotiate longer supplier terms. How far this works depends on the balance of power with suppliers.
- Terms such as 2/10, net 30 mean a 2% discount for paying within 10 days, otherwise the full amount by day 30. Skipping the discount is borrowing for 20 days at a cost of 2%.
- Compare the effective annual rate of that supplier financing with the bank rate. If the bank is cheaper, borrow from the bank and take the discount.
Unlock this lesson free for 7 days
Create a free account to get 7 days free: every lesson, video and flashcard, and the question bank. No card needed.