PART 3A
ACCRUALS

ACCRUALS
• Are accruals a source of funds or a use of funds? Is this source spontaneous? Why?
- source; spontaneous
• What are the two major categories of accruals?
- accrued wages & accrued taxes • From management’s standpoint, what is the one disadvantage to accruals as a source of funds?
- cannot be managed

• If the average quarterly tax payment is $40,000 and biweekly wage payments are
$91,250, what is the average amount of funding received through these two accrual accounts? Accrued Wages
Accrued Wages
$91,250
$45,625

91,250/2

2 wks

4 wks

Accrued Taxes

Accrued Taxes
$40,000
$20,000

40,000/2

1st qtr

2nd qtr

THE FOLLOWING SLIDE
CONTAINS
AN ADDITIONAL PROBLEM WITH
CHECK FIGURE FOR YOUR
REVIEW

Problem: The Jones Corp
• If the Jones Corp has an average quarterly tax payment of $80,000 and a biweekly payroll of $200,000, what is the combined average amount of funding received through these two accrual accounts? (check:
$140,000)

PART 3B
ACCOUNTS PAYABLE

ACCOUNTS PAYABLE
• Are accounts payable a use of funds or a source of funds? source • Is this source spontaneous?
Why?
- Yes: spontaneous source
- Automatically increase w/business • How big is accounts payable relative to other sources of funds for most companies?
- often the largest single

• Why is this source so crucial to small companies?
- may be only source of funds for small companies (that, and bank loans)

• Zippo Corp. faces terms of net 30 on annual purchases of $182.5 million. If Zippo pays on time, what is its average accounts payable balance? AcctPayAvg = (182.5 mil/365)
(30)
= $15 mil

• If purchases increase to $219 mil, how much additional funding is generated?

AcctPayAvg = (182.5 mil/365)
(30)
= $15 mil
AcctPayAvg = (219 mil/365)(30)
= $18 mil
Additional funds = $3 mil

THE FOLLOWING SLIDE
CONTAINS
AN ADDITIONAL PROBLEM WITH
CHECK FIGURE FOR YOUR
REVIEW

• If Zippo’s purchases increases from $182.5 mil to
$255.5 million, how much additional funding would be generated? (check: $6 million)

PART 3C
COST OF TRADE CREDIT

Measuring Cost of Funds
• We measure the cost of funds in terms of an annual interest rate. • The nominal interest rate ignores intra-period compounding. • The effective interest rate considers intra-period compounding. inom = $fees/$proceeds * 365/n

ief = (1 + $fees/$proceeds)365/n –
1

Cost of Trade Credit
• If Zippo’s supplier ofers terms of 2/10 net 30, what is the cost of foregoing the discount? inom = (2/98)(365/20) = 37.2% ief = (1 + 2/98)365/20 – 1 = 44.6%

• Would skipping the discount be equivalent to borrowing funds from a supplier? yes

 Zippo’s terms from its suppliers are 2/10 net 30, and annual purchases are $182.5 million, net of discounts

Rec = (Sales/365)(DSO)
- How much trade credit is free? (182.5 mil/365)(10 days) = $5 mil - How much is costly?
(182.5 mil/365)(20 days) =
$10mil

Another way to look at the nominal cost of the costly trade credit:
Looking at annual $ figures:
Purnet = Purgross(1 – disc)
182.5 = Purgross(1 - .02)
Solve: Purgross = $186.2245 mil Δcost = 186.22- 182.5 =

Stretching Payables
• What does it mean to stretch payables? - pay past final due date
• What are the shortcomings of this practice?
- costly
- damage to credit rating
- danger of being “cut of”

THE FOLLOWING SLIDES
CONTAIN
ADDITIONAL PROBLEMS WITH
CHECK FIGURES FOR YOUR
REVIEW

Problem: Harpo Corp.
• Harpo Corporation faces terms of net 60 on annual purchases of $730 million. If
Harpo pays on time, what is its average accounts payable balance? (check: $120 million) • If Harpo’s supplier ofers terms of 3/10 net 60, what is the cost of foregoing the discount? (check: inom=22.6% ief=24.9%)

- How much trade credit is free? (check: $20 mil)
- How much is costly?
(check: $100 mil)

- How much does Harpo forfeit for the year in purchase costs if it skips the discount?
(check: $22.5773 million)

Problem: Clipo Corporation
● The Clip Corporation has annual net purchases of