2024 CPA BAR Exam-Working Capital Management-Trade and Cash Discounts-Darius Clark. i75 CPA Review!

In this Video we take a Deep Dive into Working Capital/Trade Discounts and Cash Discounts for the CPA BAR Exam. These topics can be asked in multiple choice or task based simulation.
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Trade Discounts:

A trade discount is a reduction from the list price given to buyers, typically based on the volume of the purchase or the nature of the buyer (e.g., wholesalers). It allows companies to purchase inventory at a lower cost, which directly impacts the cost of goods sold (COGS) and profit margins. In working capital management, lower COGS enhances the company’s ability to maintain liquidity by freeing up cash for other short-term obligations, such as paying suppliers or covering operating expenses.

By utilizing trade discounts, companies can reduce their operating cycle (the time between purchasing inventory and receiving cash from sales), improving their cash flow position. For buyers, obtaining trade discounts enhances purchasing power and optimizes inventory management, key components of working capital.

Cash Discounts:

A cash discount, also called an early payment discount, encourages buyers to pay their invoices before the due date (e.g., "2/10, net 30" offers a 2% discount if paid within 10 days). From a seller’s perspective, offering a cash discount can help accelerate cash inflows and reduce the risk of bad debt by incentivizing prompt payment. This early receipt of cash strengthens the company's liquidity, allowing it to meet short-term obligations and invest in operational activities, which is crucial for effective working capital management.

From the buyer’s perspective, taking advantage of cash discounts reduces the actual cost of purchases, effectively improving return on investment (ROI) and reducing the need for external financing. This enables buyers to optimize their accounts payable and better control their outflows, positively affecting the cash conversion cycle.

Together, trade discounts and cash discounts are important tools in working capital management because they provide flexibility in managing both accounts payable and receivable, improve liquidity, reduce financing costs, and enhance overall financial health. Efficient management of these discounts can lead to improved cash flow and reduced working capital needs, benefiting the company’s profitability and operational efficiency.