Working Capital

Management

Payables and Overtrading

Key Learning Points

• Managing payables
• Evaluating a discount from a supplier
• Overtrading
Managing Payables
Managing payables is effectively a balancing act between:

1. Delaying payment to suppliers, to obtain a ‘free’ source of finance

2. Delaying too long may cause difficulties for the company

Trade credit is the simplest and most important source of short-term finance
for many companies.

By delaying payment to creditors companies face possible problems:

• Suppler may refuse to supply in future

• Supplier may only supply on a cash basis
• Loss of reputation
• Supplier may increase price in future
Managing Payables

Discounts:

• Trade credit is normally seen as a 'free' source of finance.

• Whilst this is normally true, it may be that the supplier offers a discount for early
payment.

• In this case delaying payment is no longer free, since the cost will be the lost
discount.
Managing Payables

Example 1

Helix Co. makes annual purchases from one its suppliers of $45,000. The normal
payment period for invoices is 90 days. The supplier has offered a 1% early
settlement discount on all purchases that are settled within 30 days.

Working capital is financed via a bank overdraft at 8%.

Required:

Should Helix Co. accept the discount offered.

Managing Payables

Example 1 - Answer

You need to really think about this!

• By using the supplier as a source of finance we do not have to finance WC via

an overdraft

• Therefore, there is a benefit of not using our overdraft

• This is financing cost that we save by using the supplier instead of the over draft

Current Finance Saving:

Managing Payables
Current finance saving:

Vs

New financing saving:

Difference

Compared to benefit of the discount

Therefore do not accept the discount and continue paying in 90 days!!!...

Managing Payables

Example 2

Bic Co. makes annual purchases from one its suppliers of $60,000. The normal
payment period for invoices is 80 days. The supplier has offered a 2% early
settlement discount on all purchases that are settled within 10 days.

Working capital is financed via a bank overdraft at 6%.

Required:

Should Bic Co. accept the discount offered.

Managing Payables
Example 2 - Answer

Current finance saving:

Vs

New financing saving:

Difference

Compared to benefit of the discount

Therefore you would accept the discount and pay early!!!...

Overtrading - (Undercapitalisation)

Overtrading is the condition of a business which enters into commitments in excess of its
available short-term resources. This can arise even if the company is trading profitably and is
typically caused by financing strains imposed by a lengthy operating cycle.

CIMA Official Terminology

Put simply a business tries to do too much, too quickly and with too little long-term capital!!!...

Overtrading tends to lead to liquidity problems as too much inventory is bought on credit and too
much credit is extended to its customers, so that ultimately there is not sufficient cash available to
pay the debts as they arise.
Overtrading - (Undercapitalisation)

Indicators of overtrading:

• Rapid increase in turnover

• No matching increase in permanent capital (overtrading is

sometimes called undercapitalisation)

• Increase in trade creditor balances

• Increasing operating cycle

• Decrease in cash/increase in overdraft

Remedies for overtrading:

• Cut back trading

• Raise further permanent capital

• Improve working capital management

Key Learning Points

• Managing payables
• Evaluating a discount from a supplier
• Overtrading
 Working Capital
Management

Payables and Overtrading