Copyright  2005 by Thomson Learning, Inc. Chapter 7 Managing Payable and Accruals Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed

Copyright  2005 by Thomson Learning, Inc. Learning Objectives v Apply time value of money principles to the payment of accounts payable. v Decide when to take a cash discount for early payment and when to pay at the end of the credit period. v Better understand the ethical issues involved in payables behavior. v Develop appreciation for role information systems play in managing payables. v To develop effective monitoring tools.

Copyright  2005 by Thomson Learning, Inc. Spontaneous Sources of Financing v Definition –a financing source occurring spontaneously from operations v Examples –payables –accruals

Copyright  2005 by Thomson Learning, Inc. Accounts Payable v Open account v Cash discount v Prox v Seasonal dating v Consignment

Copyright  2005 by Thomson Learning, Inc. Payables Decisions and the Cash Flow Timeline Time ==> Time ==> PurchaseCashCredit DateDiscount DatePeriod Time ==> Time ==> PurchaseCashCredit DateDiscount DatePeriod

Copyright  2005 by Thomson Learning, Inc. Basic Principles v Never pay early, pay on the last day of: –the discount period, or –the credit period v Take a cash discount when: –implied interest rate > opportunity rate v Stretch only as a last resort, not as a policy – notify creditor before doing so, attempt to negotiate

Copyright  2005 by Thomson Learning, Inc. Payment Decision Model v When days delayed < discount period v When days delayed > discount period v When days delayed > credit period

Copyright  2005 by Thomson Learning, Inc. When Days Delayed < Discount Period v NPV = IP x (1-d) / (1 + (DD(k/365)))

Copyright  2005 by Thomson Learning, Inc. When Days Delayed > Discount Period v NPV = IP / (1 + (DD(k/365)))

Copyright  2005 by Thomson Learning, Inc. When Days Delayed > Credit Period v IP x (1 +(DD-CP)x(f/365)) NPV = (1 + (DD(k/365)))

Copyright  2005 by Thomson Learning, Inc. Take or Leave a Discount v IP x (1-d) < IP / (1 + (CP-DP)x(k/365)) v k < (d/(1-d)) x (365/(CP-DP))

Copyright  2005 by Thomson Learning, Inc. Ethics and the Payment Decision Top Tier: Make a commitment of the will to enhance the well-being of our neighbors Top Tier: Make a commitment of the will to enhance the well-being of our neighbors Middle Tier: The “Sunlight” test: Would both interested & impartial observers find my decision to be prudent & sound? Middle Tier: The “Sunlight” test: Would both interested & impartial observers find my decision to be prudent & sound? Lower Tier: Does the decision obey the intent and letter of the law? Lower Tier: Does the decision obey the intent and letter of the law?

Copyright  2005 by Thomson Learning, Inc. Monitoring the Payables Balance v Payables turnover approach –Period purchases / Accounts payable v Days purchases outstanding –Accounts payable / Average daily purchases v Balance fraction approach

Copyright  2005 by Thomson Learning, Inc. Accruals v Definition –an expense that has been incurred but has not yet been paid v Two basic types –accrued wages and salaries –accrued interest and taxes

Copyright  2005 by Thomson Learning, Inc. Summary v A cash discount should be taken when the investment/borrowing rate is less than the annualized discount rate. v Otherwise, pay at the end of the credit period. v Payment should not be stretched past the credit period. v The balance fraction monitoring method is preferred over the payables turnover method since turnover is influenced by purchasing trends.