How to Calculate 2/10 n/30 Trade Credit Terms
Understand and calculate 2/10 n/30 trade credit. Optimize cash flow by leveraging discounts and evaluating the annualized cost of terms.
Trade credit terms, such as 2/10 n/30, are a common practice in business-to-business transactions. These terms incentivize buyers to make early payments to their suppliers. For sellers, offering such terms can help improve their cash flow by speeding up the collection of receivables. This arrangement provides a mutually beneficial structure, allowing buyers to reduce their costs and sellers to enhance their liquidity.
Deconstructing Trade Credit Terms
The “2/10 n/30” notation is a shorthand for specific payment conditions offered by a seller to a buyer. The “2%” signifies the discount percentage available if certain payment conditions are met. The “10” indicates the discount period in days, meaning the buyer must pay within 10 days from the invoice date to qualify for the 2% discount.
The “n” or “Net” refers to the full invoice amount due if the discount is not taken. The “30” represents the net payment period in days, which is the maximum time allowed for the buyer to pay the full invoice amount without penalty if they do not take the discount.
Calculating the Cash Discount
The formula involves multiplying the total invoice amount by the stated discount percentage. For example, if a business receives an invoice for $1,000 with terms of 2/10 n/30, the cash discount would be calculated as $1,000 multiplied by 2% (or 0.02). This results in a $20 discount ($1,000 \ 0.02 = $20). Therefore, if the buyer pays within 10 days, they would only remit $980 ($1,000 – $20).
Determining the Annualized Cost of Not Taking the Discount
The annualized cost of not taking a cash discount reveals the implied interest rate associated with extending the payment period beyond the discount window. This quantifies the opportunity cost of not utilizing the discount.
The standard formula for the annualized cost of not taking the discount is: (Discount % / (100% – Discount %)) \ (365 / (Net Period – Discount Period)).
- Discount %: The percentage offered.
- (100% – Discount %): The percentage of the invoice paid after taking the discount.
- 365: The number of days in a year.
- (Net Period – Discount Period): The number of additional days the buyer retains funds by not taking the discount.
Using the previous example of 2/10 n/30 terms, the annualized cost would be calculated as follows: (0.02 / (1 – 0.02)) \ (365 / (30 – 10)). This simplifies to (0.02 / 0.98) \ (365 / 20). Performing the division gives approximately 0.0204 \ 18.25, which equals approximately 0.3723 or 37.23%.
This indicates that choosing not to take the 2% discount and paying on day 30 is equivalent to borrowing money at an annualized interest rate of roughly 37.23%.