Calculate the annualized cost of trade credit from terms like 2/10 net 30, including nominal and effective rates, dollar cost, and discount vs. borrowing decisions.
Cost of Trade Credit Formula
Nominal Cost = (d / (1 - d)) * (365 / (N - D))
EAR = (1 + d / (1 - d))^(365 / (N - D)) - 1
- d is the cash discount expressed as a decimal (a 2% discount is 0.02)
- D is the discount period in days (the deadline for taking the discount)
- N is the day the invoice is actually paid, which is the net period unless you pay later
- 365 is the day-count basis (the calculator can also use a 360-day basis)
The term d / (1 – d) is the cost of one credit period. When you skip a 2% discount, you pay the full invoice instead of 98% of it, so you effectively pay 2/98 = 2.04% to keep your money for N – D extra days. The nominal formula scales that periodic cost linearly across the year, while the EAR formula compounds it, which is why the effective rate is always higher than the nominal rate.
The calculator has three modes built on these formulas. The annualized cost mode converts credit terms such as 2/10 net 30 into both the nominal and effective annual rate. The dollar cost mode applies the same math to a specific invoice amount and shows the discount you give up in dollars. The decision mode compares the effective annual cost against your borrowing rate and tells you whether taking the discount or using the trade credit is cheaper. An advanced option lets you enter the actual day you pay, so you can see how the cost changes if you stretch payment past the net date.
Annualized Cost of Common Credit Terms
The table below shows the annualized cost of forgoing the discount under common trade credit terms, assuming payment on the net date and a 365-day year.
| Credit terms | Cost per period | Nominal annual cost | Effective annual cost |
|---|---|---|---|
| 1/10 net 30 | 1.01% | 18.43% | 20.13% |
| 2/10 net 30 | 2.04% | 37.24% | 44.59% |
| 3/10 net 30 | 3.09% | 56.44% | 74.35% |
| 2/10 net 60 | 2.04% | 14.90% | 15.89% |
| 2/15 net 45 | 2.04% | 24.83% | 27.86% |
| 3/15 net 45 | 3.09% | 37.63% | 44.86% |
Trade credit is one of the most expensive forms of short-term financing a business can use. If your bank line of credit charges less than the effective annual cost in the table, borrowing to pay early and capture the discount saves money. The second table shows a less discussed effect: paying later than the net date lowers the annualized cost of skipping the discount, because the same discount buys more days of financing. The example uses 2/10 net 30 terms.
| Day actually paid | Extra days of financing | Nominal annual cost | Effective annual cost |
|---|---|---|---|
| Day 30 (net date) | 20 | 37.24% | 44.59% |
| Day 40 | 30 | 24.83% | 27.86% |
| Day 50 | 40 | 18.62% | 20.24% |
| Day 60 | 50 | 14.90% | 15.89% |
Stretching payables reduces the measured cost, but it risks late fees, damaged supplier relationships, tighter future terms, and a weaker trade credit history, so treat the lower rate as an analytical result rather than a recommendation.
Example Problems
Example 1. A supplier offers terms of 2/10 net 30 and you plan to pay on day 30. The discount is d = 0.02, so the cost per period is 0.02 / 0.98 = 2.0408%. The extra financing lasts 30 – 10 = 20 days, and 365 / 20 = 18.25 periods fit in a year. The nominal annual cost is 0.020408 * 18.25 = 37.24%. Compounding instead, the effective annual cost is (1.020408)^18.25 – 1 = 44.59%. Enter 2, 10, and 30 in the calculator’s annualized cost mode to confirm both numbers.
Example 2. You receive a $12,000 invoice with 2/10 net 30 terms and want the cost in dollars. Paying by day 10 costs $12,000 * 0.98 = $11,760, while paying on day 30 costs the full $12,000. Skipping the discount therefore charges you $240 to keep $11,760 for 20 extra days, a periodic cost of 240 / 11,760 = 2.04%. In the calculator’s dollar cost mode, enter the same terms with an invoice amount of 12,000 to see the $240 cost along with the 37.24% nominal and 44.59% effective annual rates.
Frequently Asked Questions
Why is the effective annual cost higher than the nominal cost?
The nominal cost multiplies the periodic cost by the number of periods in a year, which ignores compounding. The effective annual rate assumes each period’s cost compounds on the last, the same way an APR differs from an APY on a loan. For short credit periods repeated many times per year the gap is large: 2/10 net 30 produces 37.24% nominal but 44.59% effective. The effective rate is the correct number to compare against a bank borrowing rate, since bank rates on an annual basis already reflect a full year of financing.
Should you always take an early payment discount?
Take the discount whenever the effective annual cost of the trade credit is higher than the rate at which you can borrow. Since common terms like 2/10 net 30 imply an effective cost above 40%, and most business credit lines charge far less, taking the discount is usually the right call if you have access to cash or credit. The main exceptions are when you cannot borrow at all, when your credit line is exhausted, or when the implied cost is unusually low, such as long net periods with small discounts. The calculator’s decision mode runs this comparison directly.
What does the cost of trade credit mean for the supplier offering the terms?
The same percentage works in reverse. A supplier offering 2/10 net 30 is effectively paying customers an annualized 44.59% to collect 20 days sooner, which is expensive financing for the supplier as well. Suppliers accept this cost to accelerate cash flow, reduce collection risk, and shorten their cash conversion cycle. If a supplier can borrow more cheaply than the discount costs them, tightening the discount or financing receivables another way may be the better choice.
