1. Copyright  2002 by South-Western, a division of Thomson Learning TM Chapter 7 Managing Payables and Accruals Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Accounts Disbursement Time ==> Accounts Disbursement Time ==> Invoice Payment Cash Received Sent Paid Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Accounts Disbursement Time ==> Accounts Disbursement Time ==> Invoice Payment Cash Received Sent Paid

2. Copyright  2002 by South-Western, a division of Thomson Learning TM 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 To develop effective monitoring tools

3. Copyright  2002 by South-Western, a division of Thomson Learning TM Spontaneous Sources of Financing v Definition –a financing source occurring spontaneously from operations v Examples –payables –accruals

4. Copyright  2002 by South-Western, a division of Thomson Learning TM Accounts Payable v Open account v Cash discount v Prox v Seasonal dating v Consignment

5. Copyright  2002 by South-Western, a division of Thomson Learning TM Payables Decisions and the Cash Flow Timeline Time ==> Time ==> PurchaseCashCredit DateDiscount DatePeriod Time ==> Time ==> PurchaseCashCredit DateDiscount DatePeriod

6. Copyright  2002 by South-Western, a division of Thomson Learning TM 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

7. Copyright  2002 by South-Western, a division of Thomson Learning TM Payment Decision Model v When days delayed < discount period v When days delayed > discount period v When days delayed > credit period

8. Copyright  2002 by South-Western, a division of Thomson Learning TM When Days Delayed < Discount Period v NPV = IP x (1-d) / (1 + (DD(k/365)))

9. Copyright  2002 by South-Western, a division of Thomson Learning TM When Days Delayed > Discount Period v NPV = IP / (1 + (DD(k/365)))

10. Copyright  2002 by South-Western, a division of Thomson Learning TM When Days Delayed > Credit Period v IP x (1 +(DD-CP)x(f/365)) NPV = ---------------------------------- (1 + (DD(k/365)))

11. Copyright  2002 by South-Western, a division of Thomson Learning TM 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))

12. Copyright  2002 by South-Western, a division of Thomson Learning TM 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 “Sun Light” test: Would both interested & impartial observers find my decision to be prudent & sound. Middle Tier: The “Sun Light” 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?

13. Copyright  2002 by South-Western, a division of Thomson Learning TM 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

14. Copyright  2002 by South-Western, a division of Thomson Learning TM 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

15. Copyright  2002 by South-Western, a division of Thomson Learning TM 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.