In this lesson, we're going to look at accounts payable as a strategic source of financing. Now one of the company I've worked with in the past takes a very aggressive approach to managing their payables by delaying payments for as long as they possibly can. Now they do this of course, without trying to permanently damage the relationship they have developed with the suppliers a couple of times a year suppliers will often call them up and ask them to get back on their standard credit terms. But with this particular company, as soon as they get one of those calls, they're very good at drawing on their credit line to make the additional payments to get back within the allowed credit terms. But no sooner is that payment made and the company is again looking to stretch those payables beyond the allowed terms. So the supplier is generally happy because a couple of times of year they can demonstrate that the customer is complying with their demands, and the customer is leveraging the availability of free supplier credit as much as they possibly can.

And this is a phenomena that we are seeing across all industries these days. The other important point to make about supplier credit is that even if you have a bank line of credit available, the bank rarely finances 100% of your working capital requirement. supplier credit is one of those primary means to finance this deficiency. And without it, you're going to rely on shareholders equity and cash reserves to bridge this gap. equity is very expensive. So the bottom line is don't ignore this important source of financing.

Many vendors will provide you with between 15 and say 60 days of credit without any interest charges at all as a form of sales incentive. For example, the terms may be three and 10. net and 60, which means a 3% discount. If the invoice is paid within 10 days of receipt with the balance due after 60 days, while 60 days of free credit sounds really good, often taking advantage of the discount is more financially prudent. A company is better off to draw on, say its line of credit and realize this discount than it is to utilize the additional days of free credit provided by the supplier. Let's do some simple math. discounts should be taken when savings from the discount exceed the value from the other uses of the money.

So our formula here is that the annualized cost of the Miss discount is one divided by one minus the discount rate to the power of n minus one. So let's just do a quick example to see how this formula works. The case of three and 10 and net and 60. The effective interest rate of this discount is 21.15%. using the formula on the screen, this is likely to be significantly higher than the cost of borrowing funds using a line of credit. So one of my favorite stories to tell of a CFO who was confronted with actually a risk management issue, but utilized a number of different financing tools to minimize this risk and create value.

This was a CFO of a travel booking agency and all the client reservations were being made using a corporate credit card. But because of the number of charges hitting this, this credit card from the various clients and and suppliers, fraudulent charges were were racking up and consuming a lot of time to follow up on. So this was the impetus upon which the CFO went out and sourced a credit card company that was willing to issue virtual credit card numbers. This enabled each customer to have their own credit card, which eliminated the the fraudulent charges and got those under control. But here's where the financing strategy kicked in. At the same time, the CFO was able to negotiate a 1.5 cash back discount with the credit card for early repayments.

This equated to nearly a 25% rate of return when you take this discount and apply that formula. Since the company didn't have that cash on hand to execute the discount, the CFO simultaneously negotiated a new line of credit to be able to take advantage of the discount. And as a result of all this, the CFO firstly addressed a risk that was costing the company time and money and secondly, turn that into a new revenue stream that netted nearly a million dollars today. company's bottom line. So in this short lesson but important one, I've seen too many companies ignore supplier credit as a strategic source of financing. Now I'm not saying don't pay your bills.

What I am saying, however, is negotiate good credit terms and find ways to extend credit as long as possible without hurting your relationships with your suppliers. If your supplier is aggressively collecting their receivables like they should be, then perhaps you can negotiate an early payment discount and arrange with a bank a cheaper line of credit to take advantage of those discount opportunities. Both approaches offer your company a considerable return opportunity. That's all for this lesson. In our next lesson, we're going to look at some of the more common types of debt financing instruments. Until then