How to compute the cost of cash flow 2/10, net 40?
To compute the cost of cash flow with the terms 2/10, net 40, you need to understand the meaning of these terms.
"2/10" refers to a cash discount offered by the seller if the buyer pays within 10 days. In this case, a 2% discount is provided.
"Net 40" means that the payment is due within 40 days of the invoice date, without any cash discount applied.
To compute the cost, you need to determine the effective annual cost of not taking the cash discount and paying the full amount within the net period (40 days).
Here's how you can calculate it:
1. Determine the difference between the discount period and the net period:
Discount Period = 10 days
Net Period = 40 days
Difference = Net Period - Discount Period
= 40 days - 10 days
= 30 days
2. Calculate the annual percentage rate (APR) by dividing 365 days by the difference calculated in step 1:
APR = 365 / Difference
= 365 / 30
= 12.17 (approximately)
3. Convert the APR to a decimal by dividing it by 100:
Decimal APR = 12.17 / 100
= 0.1217
4. Calculate the effective annual cost of not taking the cash discount by subtracting the discount percentage (2%) and dividing it by (100% - discount percentage):
Effective Annual Cost = (100% - Discount Percentage) / (100% - Discount Percentage + Decimal APR)
= (100% - 2%) / (100% - 2% + 0.1217)
= 98% / 98.1217
= 0.9988 (approximately)
The effective annual cost of not taking the cash discount is approximately 0.9988 or 99.88%. This means that if the buyer does not take the cash discount and pays within the net period, the cost of the cash flow is effectively 99.88% of the invoice amount.