1.

Managing Supplier financing

Supplier financing is a component of supply chain financing and plays an important role in improving the
cash flow and operations of many companies.

Advantages of supplier financing

One of the most important advantages of supplier financing is that it is compatible with most forms of
financing. It is not designed to replace your existing financing. Instead, it is designed to enhance your
existing financing.

2. Use of supplier financing

Supplier financing works as a form of trade credit. ... When you need to purchase goods, you
place an order with the supplier finance company. Once they receive the purchase order,
the supplier finance company extends credit to your company. Then they place a
corresponding purchase order with your supplier.

3. Variations of Credit Terms

 Open account: A common credit arrangement between supplier and buyer.
 Net term: Supplier offer no discount but provide time for the buyer to pay. Example- net 30.
 Discount term: Offering a cash discount for early payment. Example- 2/10, net 30.
 Seasonal dating: Seasonal dating allows retail outlets to purchase inventory before the peak
buying season and defer payment until after the peak season.
 Consignment: Consignment is an arrangement whereby a retailer obtains an inventory items
without obligation.

4. How long should payment be delayed?

Buyers can pay:

i) On the date of purchase

ii) On or before the cash discount period

iii) After the cash discount period but on or before the end of the credit period

5. To account for differences in marginal benefits and costs across the payment option, we
apply a present value approach to determine the optimal payment strategy.
Optimal Payment Strategy

IP (1  d )
PV 
i
[1  ( )( DD)
365
Here,

 IP is the Invoice Price

 DD: Days until payment is made

 d: Discount percentage received if paid during discount period

 i: Annual opportunity cost

6. Situation 1: Cash on Delivery

Suppose, Trade credit terms 3/6, net 50

Invoice Price=$10,000

Opportunity cost = 10% or 0.10

Pv =$10000(1-0)/[1+(.10/365) * (0)

= -$10000

Because of cash on delivery, there was no present value savings

7. Situation 2: Pay the money on last day of discount period

Present value = $10000 (1-.03)/[1+(.10/365)*6]

= -$9684.50

This optimal payment strategy provide $ 315.5 relative to cash on delivery. We find this value from this
equation: [$10000+(-9684.50)]

8. Situation 3: Pay the money at the end of credit period

Pv = $10000(1-0)/[1+(0.10/365) *50

= -$9865.82

This payment strategy produces higher the present value cost of invoice. Therefore, optimal payment
strategy is to take the discount and pay on the Sixth day.
9. Suppose the firm have not enough money to repay its supplier so what strategy the firm
take to payout the supplier financing?
Annual cost of trade credit:

KTC = [.03/(1-.03)]*[365/(50-6)]

= 25.63%

10. Suppose the firm have not enough money to repay its supplier so what strategy the firm
take to payout the supplier financing?
Annual cost of trade credit
d 365
K TC =( )( )
1−d CP−DP
Where, d=Discount percentage taken if paid before discount period expire

DP=Days until discount periods end

CP= Days until trade credit period ends.

3% 365
K TC =( )( )
1−3 % 50−6
= 25.63%

If Annual cost of trade credit is greater than the annualized discount rate, then it is optimal to borrow
the funds from the bank.

11. In case of stretching trade credit, the present value cost of payment is :

IP ( 1−d ) P
PV =
¿¿

 IP is the Invoice Price

 DD: Days until payment is made

 d: Discount percentage received if paid during discount period

 i: Annual opportunity cost

 P: Extra charge or penalty

If stretching payables yielded the lowest present value cost, this strategy would not be advisable
because weakened relationships with suppliers also imply costs that are difficult to quantify.

12. Monitoring Use of supplier financing

There are two method which basically use for monitoring the supplier finance. The method is given
below:
 1. The balance fraction method:.

2. Days payable outstanding (DPO):

13. The balance fraction method

The balance fraction approach defines the proportion of each month’s trade credit obligations that is
outstanding at the end of the month. One must have access to detailed payment data to utilized the
balance fraction approach. The following table shows the balance fraction approach based on
information given in payables table:

The firm pays its supplier such that 50% of a month purchase remain at the end of the purchase month
and only 15% remain at the end of the month following the purchase month.

14. Days payable outstanding (DPO)

DPO is the traditional approach which helps to monitoring the accounts payable. Dpo provide the length
of time which help a buyer to repay its supplier, Formula of DPO is given below:

Accounts payable
¿
DPO Purchase
365
15. An Example
Week Week Week Week Week Week Week Week Week
1 2 3 4 5 6 7 8 9
Purchase $660 $560 $645 $790 $990 $980 $1090 $1100 $1260
End of the weekly 590 580 560 660 780 820 960 1020 1140
payable
Average daily 20.72 22.17 26.94 30.67 34 35.22 38.33
purchase(Quarterly
)
DPO 27.03 29.76 28.95 26.73 28.24 28.96 29.74
We can find that suppliers are repaid more quickly during week 6 and week 3. And the first highest level
DPO is 29.76 which (Week 4) takes more time than other week.