Monday, April 11, 2011

The cost involved in making an advance payment is the time value of the payments made in advance of your normal payment terms. To calculate the cost of an advance payment you need to know three basic things:
1. The Value that the company places on money.
2. The number of days in advance in which payment is required.
3. The amount of the payment being made.

The formula for calculating the cost of an advance payment is:
Cost per day (value of money divided by 365)
X number of days (Usually starting at Net 30 and counting back)
X Payment Made (Amount of Payment made)
= Cost of Advance Payment

Assume in this case that your value of money is 12% or ..0328767 a day

Example:
Two vendors have quoted on a tooling job.
Vendor 1's terms are:
Cost: \$100,000
Payment: 50% with order 50% with first article.

Vendor 2's terns are:
Cost: \$101,000
Payment: 25% with order 75% on production commencement.

The schedule is as follows:
Place orders: 1 June (230 days advance)
First Article: 28 September (100 days advance)
Production: 12 December (30 days advance)
Net 30 pay: 12 January (0 days advance)

To compare the two you must calculate the cost of advance payments:
For vendor 1:
You have paid:
\$50,000 paid 230 days in advance
\$50,000 paid 100 days in advance

1. For the first payment made, take 230 days x the daily rate .0328767 = 7.56 percent
2. You then multiply the percentages (7.56%) by the amount of the payment (\$50,000) for the cost of the one payment (\$3,780.00.)
3. You repeat the process for the second payment (100 days x daily rate of .032876 = 3.26%.
4. You multiply 3.28% by the amount of the payment \$50,000 = \$1,630.
5. The total cost of the advance payments for vendor 1 is \$3,780 + 1,630 or \$5,410
6 The total cost of Vendor 1 is \$100,000 (the price) + 5,410 (the advance payment cost) or \$105,410.

For vendor 2:
You have paid:
\$25,250 paid 230 days in advance
\$75,250 paid 30 days in advance

1. For the first payment made, take 230 days x the daily rate .0328767 = 7.56 percent
2. You then multiply the percentages (7.56%) by the amount of the payment (\$25,250) for the cost of the one payment (\$1,908.90.)
3. You repeat the process for the second payment (30 days x daily rate of .032876 = .985%
4. You multiply .985% by the amount of the payment \$75.250 = 741.31.
5. The total cost of the advance payments for vendor 2 is \$1,908.90 + 741.31 or 2.650.21
6. The total cost of Vendor 2 is \$101,000 (the price) + 2,650.21 (the advance payment cost) or \$103,650

What I would then do is tell Vendor 1 that they aren’t competitive when you take into account the cost of the advance payment requirements to get those to change those terms so I would get the best of both, the lowest price and competitive payment terms.

1. 2. 