Chapter 7 Managing Payables and Accruals Order Placed
Chapter 7 Managing Payables and Accruals Order Placed Order Received Sale Cash Received Accounts Collection < Inventory > < Receivable > < Float > Accounts < Payable > Invoice Received Disbursement < Float > Payment Sent Time ==> Cash Paid Copyright 2002 by South-Western, a division of Thomson Learning TM
Learning Objectives v Apply time value of money principles to the payment of accounts payable v Decide when to take a cash discount for early payment and when to pay at the end of the credit period v Better understand the ethical issues involved in payables behavior v To develop effective monitoring tools Copyright 2002 by South-Western, a division of Thomson Learning TM
Spontaneous Sources of Financing v Definition – a financing source occurring spontaneously from operations v Examples – payables – accruals Copyright 2002 by South-Western, a division of Thomson Learning TM
Accounts Payable v Open account v Cash discount v Prox v Seasonal dating v Consignment Copyright 2002 by South-Western, a division of Thomson Learning TM
Payables Decisions and the Cash Flow Timeline Time ==> Purchase Date Cash Discount Date Credit Period Copyright 2002 by South-Western, a division of Thomson Learning TM
Basic Principles v Never pay early, pay on the last day of: – the discount period, or – the credit period v Take a cash discount when: – implied interest rate > opportunity rate v Stretch only as a last resort, not as a policy Copyright 2002 by South-Western, a division of Thomson Learning TM
Payment Decision Model v When days delayed < discount period v When days delayed > credit period Copyright 2002 by South-Western, a division of Thomson Learning TM
When Days Delayed < Discount Period v NPV = IP x (1 -d) / (1 + (DD(k/365))) Copyright 2002 by South-Western, a division of Thomson Learning TM
When Days Delayed > Discount Period v NPV = IP / (1 + (DD(k/365))) Copyright 2002 by South-Western, a division of Thomson Learning TM
When Days Delayed > Credit Period v IP x (1 +(DD-CP)x(f/365)) NPV = -----------------(1 + (DD(k/365))) Copyright 2002 by South-Western, a division of Thomson Learning TM
Take or Leave a Discount v IP x (1 -d) < IP / (1 + (CP-DP)x(k/365)) v k < (d/(1 -d)) x (365/(CP-DP)) Copyright 2002 by South-Western, a division of Thomson Learning TM
Ethics and the Payment Decision Top Tier: Make a commitment of the will to enhance the well-being of our neighbors Middle Tier: The “Sun Light” 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? Copyright 2002 by South-Western, a division of Thomson Learning TM
Monitoring the Payables Balance v Payables turnover approach – Period purchases / Accounts payable v Days purchases outstanding – Accounts payable / Average daily purchases v Balance fraction approach Copyright 2002 by South-Western, a division of Thomson Learning TM
Accruals v Definition – an expense that has been incurred but has not yet been paid v Two basic types – accrued wages and salaries – accrued interest and taxes Copyright 2002 by South-Western, a division of Thomson Learning TM
Summary v A cash discount should be taken when the investment/borrowing rate is less than the annualized discount rate v Otherwise, pay at the end of the credit period v Payment should not be stretched past the credit period v The balance fraction monitoring method is preferred over the payables turnover method since turnover is influenced by purchasing trends. Copyright 2002 by South-Western, a division of Thomson Learning TM
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