Paying early, on time or late: AP and cash
The $18,000 drill bill paid on day 10, 30, 45 and 60: the discount is worth $321.34, and lateness costs more than the cash it keeps.
Trade credit is the cheapest-looking money a startup can get: the vendor ships now and takes payment in 30 days. Using the whole term is fair, because the vendor agreed to it. Paying later than the term is something else. It is borrowing from a vendor that did not agree to lend, at a price the contract may set. The two earlier lessons gave the formulas: the cost of skipping a discount and the way DPO misleads. This one puts payment days side by side.
The facts: the $18,000 drill bill on 2/10 net 30, idle cash earning 4% a year, and a vendor whose contract adds a late fee of 1.5% for each month or part of a month. Only the contract says what a vendor charges. This one is assumed, to show the shape of the trade. Each row is what paying on that day is worth against paying on the due date.
Inside the window the discount wins by a wide margin: $360 off, less the interest on the cash that left 20 days early. Between the window and the due date paying early gives away interest for nothing. After the due date, the cash earns a little and the late fee takes far more. Holding $18,000 for 15 days at 4% earns $29.59. The fee clause costs $270.
Take the discount
- Good at
- The best return available on the cash
- $360 off the cost of the drills
- Watch for
$17,640 leaves 20 days early
- Best for
- A startup holding cash from a round
Pay on the due date
- Good at
- Full use of the term
- The vendor keeps extending credit
- Watch for
Needs a calendar, and the payment run has to run on time
- Best for
- Almost every bill
Negotiate longer terms
- Good at
Cash stays in the bank without a fee or a hard feeling
- Watch for
The vendor may want something back: volume, autopay, a deposit
- Best for
- A volume buyer with a good record
Pay late and hope
- Good at
Cash stays in the bank a little longer
- Watch for
- Late fees, a credit hold or a demand for cash up front
- A vendor that stops answering when something is wrong with an order
- Best for
- No one
Step 1: See what is coming
List what is due in the next 7, 14 and 30 days, and the cash available after payroll and taxes.
Step 2: Take the discounts that expire
Discounts that close before the next run come first, because they are worth the most per day.
Step 3: Rank the remainder
Pay the rest on the due date. If cash does not cover it, rank by what hurts most to miss: payroll, taxes, rent, then a vendor you cannot replace.
Step 4: Talk to the vendor first
For anything that will be late, call before the due date and put the new date in writing.
Step 5: Release and forecast
Release the run, see the balance it leaves, and update the forecast with what was actually paid.
The vendor's term is Northwind's to use in full, and past it the cash earns pennies while the fee costs dollars.
Finished this lesson?
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 405 (opens in a new tab)LiabilitiesFree after registration
- Background reading — not an authority
- Wikipedia, “Net D” (opens in a new tab)Net D — payment termsFree to read
- Wikipedia, “Days payable outstanding” (opens in a new tab)Days payable outstandingFree to read
The full map is in US GAAP, and where these rules come from.
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- DPODPO is a liquidity and working-capital metric, calculated as (Ending AP ÷ COGS for the period) × Days in the period.Convention
- CCCDSO + DIO − DPO: the days between paying suppliers and collecting from customers. Negative means customers pay before suppliers are paidConvention
- Payment termsThe agreed timing of payment and any early-payment discount — Net 30, Net 30 EOM, 2/10 net 30, due on receipt; the due date that aging is measured fromConvention
- Early-payment discountA reduction offered for paying before the net due date — 2/10 net 30 is 2% off if paid in 10 days, an annualized return of about 37%Convention
- Working capitalWorking capital is a liquidity and working-capital metric, calculated as Current assets − Current liabilities.Convention
- Payment runA batch of payments released togetherConvention
- Trust fund recovery penaltyA penalty of 100% of the withheld income tax and employee FICA a business failed to pay over, assessed personally on each responsible person who acted willfully — an officer, or anyone who signs the checks
- Payment floatThe time between issuing a payment and the cash leaving the bank account — for a check, from the day it is written to the day it clears. The outstanding checks at period end are the float the bank reconciliation carriesConvention
See also
- Procure to pay (AP)The payables stack from requisition to reconciliation: requisition → PO → receipt → bill → approval → payment → reconciliation.
- Cash & treasuryCash is the only balance sheet account where an independent third party, the bank, says what the balance should be. That makes it the easiest account to verify and the one where a break hurts most.
- Payment terms & due datesDue dates from payment terms, and whether an early-payment discount is worth taking.
- DPO calculatorDPO is a liquidity and working-capital metric, calculated as (Ending AP ÷ COGS for the period) × Days in the period.
- Cash conversion cycle calculatorDSO + DIO − DPO: the days between paying suppliers and collecting from customers. Negative means customers pay before suppliers are paid
- DSO vs DPODSO counts the days of sales customers haven't paid for yet. DPO counts the days of purchases the company hasn't paid for. With inventory days, they make up the cash conversion cycle.
- Vendor payment terms and early-pay discounts, explainedWhat Net 30 and 2/10 net 30 really mean, the annualized cost of skipping an early-pay discount, and how to schedule payment runs around your cash.
- Payment terms explained: Net 30, discounts and late feesHow to choose payment terms, count a due date, price an early-payment discount, set lawful late fees and work with enterprise procurement.
- CashRequirementsDue in 7/14/30 vs. available, payroll broken out.
- PaymentRunBuilderShows the cash balance remaining after the run.
- PaymentRunPreviewHold-to-confirm. Partial failure is a first-class state.