Question

Suppliers may provide a cash discount for early payment and foregoing discounts can be very expensive. Whether a firm should take a discount depends on the relative costs of alternative sources of financing.

Under what circumstances would it be advisable to borrow money to take a cash discount?

Answer 1

Answer –

A firm provides discounts to customers due to various reasons like indirectly lowering down the prices of goods and attracting them, accelerating the cash flow with early receivables, reducing risks of non payments at the end of due date, it could be a sources of financing for suppliers to gain more business.

Yes, a firm should take a discount depending upon the relative costs of alternative sources of financing. A firm should compare the cost of credits given to customers with the cost of other alternative sources of financing. If costs of trade credit is less then only firm should take a discount option.

A buyer could borrow money from outside source to avail the cash discounts by paying early to the supplier only when the cost of borrowing the money is less than the cash discount offered or cost of trade credit. Buyer should calculate the effective cost of trade credit and cost of borrowing, only if cost of borrowing is less then it is advisable to borrow money to take a cash discount.