Question 19.6: The Rowd Company has an average accounts payable balance of ...
The Rowd Company has an average accounts payable balance of $250,000. Its average daily cost of goods sold is $14,000, and it receives terms of 2/15, net 40 from its suppliers. Rowd chooses to forgo the discount. Is the firm managing its accounts payable well?
PLAN
Given Rowd’s AP balance and its daily COGS, we can compute the average number of days it takes to pay its vendors by dividing the average balance by the daily costs. Given the terms from its suppliers, Rowd should either be paying on the 15th day (the last possible day to get the discount), or on the 40th day (the last possible day to pay). There is no benefit to paying at any other time.
EXECUTE
Rowd’s accounts payable days outstanding is $250,000/$14,000 = 17.9 days. If Rowd made payment three days earlier, it could take advantage of the 2% discount. If, for some reason, it chose to forgo the discount, it should not be paying the full amount until the 40th day.
EVALUATE
The firm is not managing its accounts payable well. The earlier it pays, the sooner the cash leaves Rowd. Thus, the only reason to pay before the 40th day is to receive the discount by paying before the 15th day. Paying on the 18th day not only misses the discount, but costs the firm 22 days (40–18) use of its cash.