Monday, May 31, 2021

Calculating the Cost of Delay

Happy Memorial Day to all and a heartfelt thank you to all those who serve and have served our country. Your sacrifices are truly appreciated by TRET.

Let us quickly discuss, on this last day of May, the value of Delay. Late payments, be they intentional or not, are costly, no matter how late they are. Time has a calculable value and delayed payments provide a monetary benefit to the payee and punish the lender or vendor. This value is easily observed in the world of retail, where giants like Wal-Mart, not only connect the speed with which they pay their vendors to the success of the products in their stores, but also fine retailers for late shipments. In retail, late shipments equate to lost sales. In real estate, late payments lead to increased opportunity costs and decreased value of money.

So, how costly is a delayed payment? Each day of delay is equaled to the risk-free rate of investment, divided by 365 and multiplied by the amount of the payment. For example: a $1000 payment that is 15 days late at a risk free rate of 5% would be:

(0.05/365) x $1000 x 15 = $2.10

In this instance, the borrower, tenant or lessee has collected or saved $2.10 by delaying the payment 15 days. These types of losses can become substantial as payment amounts rise or  late payments become more frequent.

The rate of return of a T-bill is usually used as the risk-free rate. Opportunity costs can also be calculated by substituting the rate of return of the alternative or intended investment for the risk free rate.

So, there you have it, a quick take on the cost of delay, just before the month ended. Your comments are welcomed below.

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