# Cost of Trade Credit Calculator

The cost of trade credit calculator can be used to calculate the annualized cost of offering early payment discounts to customers or alternatively of not taking early payment discounts from suppliers.

## Cost of Trade Credit Formula

The calculator uses the cost of trade credit formula based on a 365 day year as shown below:

Cost of trade credit =(1 + d /(1 – d)) (365 / (Normal days – Discount days)) – 1
Where
d = Early payment discount percentage
Normal days = Normal credit terms offered
Discount days = Days in which discount can be taken

The formula is based on the effective annual rate (EAR) formula which calculates the rate of interest for a year based on a nominal interest rate compounded a number of times a year.

## Cost of Trade Credit Calculator Formula

As an example of the use of the calculator, suppose a business offers 2/10 net 30 terms to customers which means a 2% discount (d) is allowed if the customer pays within 10 days (discount days) otherwise full payment is due within 30 days (normal days). If the customer takes the discount then the amount less the discount is paid 20 days early, but a cost equal to the discount is incurred.

The cost of trade credit can then be calculated using the formula as follows:

```d = 2%
Normal days = 30
Discount days = 10

Cost of trade credit = (1 + d /(1 - d)) (365 / (Normal days - Discount days)) - 1
Cost of trade credit = (1 + 2% /(1 - 2%)) ^(365 / (30 - 10)) - 1
Cost of trade credit = 44.59%
```

In this example, the cost of having the use of the funds for an additional 20 days is equivalent to an annualized cost of trade credit of 44.59%. This means that if the business is able to borrow the funds at less than 44.59% it should do so rather than offer the early payment discount.

A similar calculation can be carried out to determine whether or not to take a discount offered by a supplier. In this case if the business does not take the discount and pay early, then it has the use of the funds for a further 20 days, however, this is done at the cost of not taking the discount of 2%. Using the same formula the cost of not taking the discount will be the same as in the example above 44.59%. If the business can borrow at a rate less then this then it should do so and take the early payment discount. ## Using the Cost of Trade Credit Calculator

The Excel cost of trade credit calculator, available for download below, is used to compute the annualized cost of either offering an early payment discount to customers or not taking an early payment discount from suppliers. The calculator is used as follows:

1. Enter the normal days. The normal days is the normal credit terms in which an invoice is due for payment. For example, if the terms are 2/10 net 30, the normal days would be entered as 30.
2. Enter the discount days. The discount days is the number of days in which payment must be made to get the early payment discount. For example, if the terms are 2/10 net 30, the discount days would be entered as 10.
3. Enter the early payment discount. The early payment discount is the discount offered for early payment of the invoice. For example, if the terms are 2/10 net 30, the early payment discount would be entered as 2%. The cost of trade credit calculator calculates the annualized cost of trade credit based on a 365 day year.