Explain the Extending Payments to Vendors for Inputs, Products, or Services Rendered to the Last Possible Date Prior to a Penalty. Is There a Downside to Such a Strategy

Extending Payments to Vendors to the Last Possible Date Prior to a Penalty

The only downside to such a strategy is not taking advantage of the cash discount window.

Explanation:

Otherwise, there is no cost to the firm if it takes advantage of the credit period extended by vendors.  However, extending payments should be weighed against the opportunity for a cash discount.  It has been established that the discount for early payment can be substantial when annualized.  For example, if a vendor gives trade terms of 2/30, net 60, it implies that a 2% cash discount is allowed for purchases if payment is made within 30.  The 2% discount for 30 days amounting to 24% per year. However, since the vendor will not apply any penalty until after 60 days, the firm should weigh the costs of the discount within the 30-day discount window versus the extra 30 days credit grace period.  Whichever option makes financial sense to the firm should be accepted.  But the firm should be wary of delaying payments after 60 days, because a penalty of 2% applies.

answerreactive approach;