Interest-free Credit

Although buying food on a credit account has practically disappeared, buying household goods like clothing or consumer durables on credit has increased very considerably. The simplest credit purchase is one where the seller sets a retail price for an article and offers to accept, say, a 20% deposit and the balance in equal monthly instalments - often nine instalments - no interest or other charge being made. If the retail price were £100 the deposit would be £20 followed by nine payments each of £8.89.

As with the old-fashioned family grocer giving interest-free credit, a shopkeeper offering deferred terms without making any charge for them must be pricing his goods at a high enough level to cover the interest he will have to pay on the extra capital employed (if he is having to borrow the capital), or the interest he is forfeiting on capital (if he is using his own resources). A would-be cash purchaser at such a shop would reasonably expect to be able to obtain a discount off the marked retail price. But he will have to ask for it; a shop offering interest-free credit is unlikely at the same time openly to admit that the goods would have been cheaper if the buyer were not to take credit, for to do so would belie the offer of `free' credit.

How much discount?

To determine what a reasonable discount rate would be, one can work out what the credit being offered free is actually costing the supplier. If the cost of money is, say, 10% per annum, a customer taking £80 credit repayable in nine monthly instalments is, in effect, borrowing £80 for one month, £71.11 for two months, and so on. He is borrowing less and less as the nine months pass. If it were to be mathematically calculated, the interest element would effectively be the interest for nine months on approximately half the original amount borrowed. Interest at 10% on £40 over nine months is £30. So a £30 discount for cash (nearly 4%) would be an appropriate rate. If a shop will not agree to giving discount for cash the purchaser will very likely find he can buy the item £30 cheaper from another establishment not offering free credit.

Advantages of discount

The following advantages could accrue to a trader giving discount:

(a) economy in use of capital, having less tied up in 'sundry debtors';

(b) increase in sales, although profit per unit is smaller;

(c) no need to keep complex website-keeping records of credit sales and amounts outstanding.

• Part Three - Sources And Costs of Personal Finance
• Motor Insurance