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Is a 2/10 net 60 discount worth taking?

The rate is the easy half. The half that decides it is what the shorter payment terms do to net debt, and who in the building is measured on which.

Julian R. Sterling · from Treasury Management

Terms of 2/10 net 60 mean paying two per cent less if you pay on day 10 instead of day 60. Not taking the discount is borrowing the money from the supplier for 50 days, and the annualised cost of that loan is 14.8980 per cent. Against a revolver at 4.50 per cent, taking it is worth 5,471,890.41 a year.

The rate, in one line

Two per cent buys 50 days — day 10 to day 60. The discount is taken on the invoice, so the amount actually financed is 98 per cent of it: 2 / 98 × 365 / 50 = 14.8980 per cent.

That is the number to compare with the cost of funding, and it is the reason the answer is usually yes. On this company the drawn revolver costs 4.50 per cent and the term loan 4.75 per cent; even the overdraft rate of 5.50 per cent is a fraction of it.

The full arithmetic, not just the rate

The discount is worth taking at any funding cost below 14.8980 per cent.

	Amount
Purchases carrying the offer — 40 per cent of cost of goods sold	392,000,000.00
Discount captured at two per cent	7,840,000.00
Cost of funding 50 days on the revolver at 4.50 per cent	−2,368,109.59
Net gain, per year	5,471,890.41
Average cash tied up	52,624,657.53

The half that gets left out

Paying on day 10 instead of day 60 shortens days payable outstanding on those invoices, so the cash conversion cycle lengthens and reported net debt rises by the average balance no longer owed.

5,471,890.41 a year against 0.3132 turns of reported leverage. The covenant headroom decides whether that trade is available.

	Before	After taking the discount
Net debt on reported cash	336,000,000.00	388,624,657.53
Leverage on that reading	2.0000×	2.3132×
Cost in turns		0.3132

So the honest answer has two parts. The discount is worth 5,471,890.41 a year and is worth taking at any funding cost below 14.8980 per cent — unless the 0.3132 turns matter, which they do only if a covenant is close. On this company the binding test has 0.6310 turns of headroom on the facility's own definition of cash, so the trade is available; on a company with half a turn, it is not.

Why it is refused anyway

Nobody is measured on it. The payables team is measured on days payable outstanding, and taking the discount makes their number worse. The treasurer is measured on cash and on covenant headroom, and does not see the invoice terms. The line is worth 5,471,890.41 a year and it sits between two people, each of whom is doing their job.

That is also why the fix is not a policy but an arithmetic one: price every early-payment offer in the same unit as the funding it replaces, and put the answer in front of whoever owns the funding cost. The generalisation is dynamic discounting — a discount priced on the days actually saved rather than a fixed two per cent — and it is the same computation with the rate solved for instead of assumed.

What to do with this

Take the terms off the largest twenty suppliers, annualise each offer with d / (1 − d) × 365 / (net days − discount days), and compare the result with your marginal cost of funds. Then compute what taking them all does to net debt, and check it against the headroom on the covenant's own definition of cash before deciding. Two numbers, and the second one is the one that gets forgotten.

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