Introduction to Finance

Terms for Trade Credit 
Sales may be made on terms such as cash, end of month 
(E.O.M.), middle of month (M.O.M.), or receipt of goods (R.O.G.). Or such terms as 2/10, net 
30 may be off ered, which means the purchaser may deduct 2 percent from the purchase price 
if payment is made within ten days of shipment; if not paid within ten days, the net amount is 
due within 30 days. Such 
trade discounts
to purchasers for early payment are common and 
are designed to provide incentive for prompt payment of bills. Occasionally, sellers off er only 
net terms such as net 30 or net 60.
A cash sale, contrary to its implication, usually involves credit because the purchaser is 
often permitted a certain number of days within which to make payment. For example, a sale 
of merchandise in which the purchaser is permitted up to ten days to pay may be considered a 
cash transaction, but credit is outstanding to the purchaser for that time. Even for the fi rm that 
purchases products entirely on a cash basis, the volume of accounts payable outstanding on its 
books at any one time may be large.
Cost of Trade Credit 
When trade credit terms do not provide a discount for early pay-
ment of obligations, there is no cost to the buyer for such fi nancing. Even when discounts are 
available, it may seem that no cost for trade credit exists, since failing to take the early pay-
ment discount requires the purchaser to pay the net price. A cost is involved, however, when 
a discount is not taken. For example, with terms of 2/10, net 30, the cost is the loss of the 2 
percent discount that could have been taken if payment were made within the ten-day period.
To compare the cost of trade credit and bank credit, the cost of the trade credit must be 
placed on an annual interest rate basis. For example, if the terms of sale are 2/10, net 30, the 
cost of trade credit is the loss of the 2 percent discount that the purchaser fails to take if she 
or he extends the payment period from ten days up to 30 days. The lost 2 percent is the cost 
of trade credit for those 20 days. If we consider that it is the discounted price (invoice price 
minus the percentage discount) that is being fi nanced, the approximate eff ective cost (EC) is 
the following:
EC =