Which formula represents the cost of financing receivables?

Which formula represents the cost of financing receivables?

• A. Annual sales x (receivable days/365)
• B. Receivable balance x interest (overdraft rate)
• C. Cost of credit administration x rate
• D. Units sold x days outstanding

Answer: (B)

The main idea is that the cost of financing receivables is the interest expense on the funds tied up in those receivables. Money invested in customers’ credit sales could be borrowed at the prevailing rate, so the annual financing cost is the receivables balance multiplied by the interest rate used to finance them (often the overdraft rate). For example, if average receivables are 500,000 and the overdraft rate is 8%, the annual financing cost would be 40,000. This formula directly represents the cost of carrying those receivables as a financing charge. The other options either estimate the amount financed, relate to credit administration costs, or are not meaningful measures of financing cost.

The main idea is that the cost of financing receivables is the interest expense on the funds tied up in those receivables. Money invested in customers’ credit sales could be borrowed at the prevailing rate, so the annual financing cost is the receivables balance multiplied by the interest rate used to finance them (often the overdraft rate). For example, if average receivables are 500,000 and the overdraft rate is 8%, the annual financing cost would be 40,000. This formula directly represents the cost of carrying those receivables as a financing charge. The other options either estimate the amount financed, relate to credit administration costs, or are not meaningful measures of financing cost.