Introduction to Finance

%
discount
100
%
−
%
discount
×
365 days
Credit period − discount days
(16-4)
trade discounts 
provided to 
purchasers as an incentive for 
prompt payment of bills
9
We discussed the process of credit evaluation in Chapter 15.

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16.4 Nonbank Short-Term Financing Sources
505
For our 2/10, net 30 example, we have, as follows:
EC =
2
%
100
%
− 2
%
×
365
30 − 10
= 2.04
%
× 18.25 = 37.2
%
This shows that the cost of trade credit typically exceeds the cost of bank loan rates. Thus, 
it is usually worthwhile to borrow funds to take advantage of cash discounts on trade credit. 
Failure to take advantage of the trade discount is the same as borrowing from the vendor at 
the eff ective cost.
10
The cost of trade credit in most lines of business activity is high when discounts are 
missed. However, it should not be assumed that high cost necessarily makes trade credit an 
undesirable source of short-term fi nancing. It can be the most important form of fi nancing 
for small and growing businesses unable to qualify for short-term credit through customary 
fi nancial channels.
The fi rm in a weak fi nancial condition will fi nd trade credit more available than bank 
credit. The bank stands to gain only the interest on the loan if repayment is made, but it will 
lose the entire sum loaned if the borrower’s obligation is unmet. The manufacturer or mer-
chant, on the other hand, has a profi t margin on the goods sold. If the purchaser fails to meet 
the obligation, the maximum the seller will lose is the cost of the goods (COGS) delivered to 
the purchaser.
Commercial Finance Companies 
The fi rst commercial fi nance company in the United States was chartered about 100 years ago. 
Since that time, the number of these institutions has increased to more than 500. Some of these 
organizations are small, off ering limited fi nancial services to their customers, while others 
have vast resources and engage in broadly diversifi ed programs of business lending.
A