I recall once hearing the math teacher tell our class that “mathematicians were an inherently lazy people”. Now, he certainly wasn’t making a disparaging remark about mathematicians, because he was one himself. But, the point he was making, was that they are constantly applying techniques to reduce equations to their simplest terms so that they are easier to work with. Or, in the case of preparing for the CTP exam, making it easier to recall an equation in the event you have to use it to correctly answer a calculation question. So today, I’m going to give you an equation from the BOK that I’ve restated in less complicated terms.
This equation is being introduced in the ETM 3rd Ed. and is used in the “Float Neutral Calculation” (FNC) which can be found in the following exam preparation resources:
- AFP Learning System, Treasury- Participant Guide, Pg. S4-15, Slide 37
- ETM 3rd Ed., Pages 236-237
The equation and example as presented in the BOK can be restated as follows:
| Discount |
= |
(r x TD)/365 |
| Where |
|
r = 12% |
| |
|
TD = 3 days |
| Discount |
= |
(.12 x 3)/365 |
| |
= |
.000986 |
| |
= |
.001 (rounded) or 1% |
From an operational standpoint, this calculation can serve as a valuable trading partner negotiation tool. Because you can quantify the benefit (i.e. the discount) to be given to a customer to compensate them for the loss of float that will result from the implementation of a seller’s e-commerce initiative.
For example, the FNC could be used to solve the following exam question which is a variation of the BOK sample application:
“A seller currently gives its customers credit terms of Net 45, but wants to start electronically drawing the payment for products sold from the customers’ bank accounts on the day of delivery. If the customers’ opportunity cost of funds is typically12%, what is the discount the seller should give to their customers to compensate them for their loss of float”?
| Discount |
= |
(.12 x 45 days)/365 |
| |
= |
.01479 |
| |
= |
.015 (rounded) or 1.5% |
Finally, the less complicated form of the FNC that I’ve suggested is actually a variation of and therefore can be derived from the “Cost for a Buyer of Not Taking the Cash Discount” equation. You might want to take a look at this equation to see how it is related to the FNC because it might help give you a better understanding of both of these equations an how they can be applied.
-George Schilling, CTP
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