A buyer agrees the price and then says “payment in sixty days.” The price on the
invoice has not changed, so it feels like nothing was given away. But the fabric and the
wages were paid weeks ago. Those sixty days are a loan from you to the buyer, and a loan has
a cost.
What you have paid out, not what you will receive
While you wait, the money tied up is what you have spent on the order, not what you
will be paid. The wait costs the interest on that money, for as many days as you wait:
The sum
total cost of the order × yearly interest rate × days ÷ 365.
A worked example
These figures are made up to show the sum. They are not a benchmark and not a claim about
any unit or any interest rate. The garment is the one in the
costing example: a total cost of
₹738.30, a price of ₹996.71 and a profit of ₹258.41. The interest rate is an
assumption, 12% a year; use what your own money costs you, whether a loan or an overdraft.
An order of 1,000 garments is an invoice of ₹996,710, and you have spent
₹738,300 by the time it ships. Waiting 60 days costs
738,300 × 0.12 × 60 ÷ 365 = ₹14,564, which is
₹14.56 a garment.
The same order at other terms
- 30 days: ₹7,282, or ₹7.28 a garment. 2.8% of the profit.
- 60 days: ₹14,564, or ₹14.56 a garment. 5.6% of the profit.
- 90 days: ₹21,846, or ₹21.85 a garment. 8.5% of the profit.
The cost is in proportion to the wait: ninety days costs three times thirty. A price that
made sense on 30 days is a thinner price on 90, and nothing on the invoice shows it.
Giving a discount for earlier payment
Buyers sometimes offer the reverse: pay in 10 days instead of 60 if you take 2% off. It
sounds small. Work out what it is as a yearly rate. Taking 2% off the price to be paid
50 days earlier is 2 ÷ 98 × 365 ÷ 50 = 14.9% a year.
Compare that with what your money costs. At 12%, paying 14.9% to get paid early is dearer
than waiting, so the discount is not worth giving. If your money costs more than 14.9%,
because you borrow short-term at a high rate, it is. The offer is the same; the answer
depends on you.
Turn every term into a rate
Days, and a discount, can both be converted into a yearly percentage. Once they are, they can
be set against each other and against the interest you actually pay.
What to do with it
- Add the cost to the quote. The ₹14.56 is 1.5% of the price. A
quote for 60 days can carry it as a line.
- Count the days from the invoice, not from the order. Production and
shipping time add to the wait before the clock even starts.
- Ask for part-payment up front on a first order with a new buyer. That
reduces the money tied up and the risk.
What the sums leave out
- A made-up rate. 12% is an assumption. A unit using its own cash has a
cost too, the return it could have earned elsewhere.
- Late payment. The sums assume the buyer pays on the day. Every week
beyond it is a further cost, and the risk of not being paid is not in the interest at
all.
- Simple interest. Over a few months the difference from compounding is
small, and the sums here use the simple figure.
- Advance payments from the buyer. They reduce the money you have tied
up. Take them off the cost, the same way.
The payback and EMI article sets out the
other half of the unit's money: what a machine costs to finance. Between them, you can see
what borrowing is doing to a garment's margin, and the
costing calculator takes the garment itself from there.