Equivalent Annual Discount Rate Calculator
Calculate the effective annual cost of foregoing a cash discount (Trade Credit).
What is an Equivalent Discount Rate?
In corporate finance and accounting, the Equivalent Discount Rate typically refers to the annualized cost of foregoing a cash discount offered by a supplier. This is also known as the "Cost of Trade Credit."
Suppliers often offer terms like "2/10 net 30". This means you can deduct 2% from the invoice amount if you pay within 10 days; otherwise, the full amount is due in 30 days. While 2% might sound small, skipping this discount essentially means you are borrowing the money for the remaining 20 days at a very high implied interest rate.
Why Calculate the Equivalent Rate?
Businesses use this calculation to make financing decisions. If a company's cost of capital (or the rate at which they can borrow money from a bank) is lower than the Equivalent Discount Rate, they should borrow money to pay the supplier early and take the discount.
The Formulas
This calculator determines two key metrics based on the discount terms ($d$), the discount period, and the net period.
1. Nominal Annual Rate (APR):
This formula calculates the simple annualized interest rate.
APR = (Discount % / (100% – Discount %)) × (365 / (Net Days – Discount Days))
2. Effective Annual Rate (EAR):
This formula accounts for compounding, assuming you would repeat this transaction throughout the year. This is the most accurate measure of the true financial cost.
EAR = [1 + (Discount % / (100% – Discount %))] ^ (365 / (Net Days – Discount Days)) – 1
Realistic Example
Let's assume a supplier offers terms of 2/10 net 30 on a $10,000 invoice.
- Option A: Pay $9,800 on Day 10.
- Option B: Pay $10,000 on Day 30.
If you choose Option B, you keep your $9,800 for an extra 20 days (30 days – 10 days), but it costs you $200 to do so.
Using the calculator:
- Discount: 2%
- Days Borrowed: 20 days
- Effective Annual Rate (EAR): 44.59%
This means foregoing the discount is mathematically equivalent to taking out a loan with an annual interest rate of 44.59%. Unless your business is in a severe cash flow crisis, you should almost always take the discount.