Looking for ways to save money and improve cash flow? Consider taking advantage of early payment discounts.
Many Suppliers offer discounts to Customers who pay their invoices before the due date. These discounts can range from a few percentage points to significant savings. By paying early, you not only save money but also build strong relationships with your Suppliers.
In this guide, we’ll explain what early payment discounts are, how they work, and the benefits they can bring to your company. We’ll also provide tips on effectively managing cash flows to fully utilize these discounts. Let’s dive in and start saving! Read more What is 3-way matching and why is it important?
💵 Early Payment Discount – definition 💵
Early payment discount is a form of dynamic discounting aimed at expediting the payment process. It allows Suppliers to offer discounts on invoices if payment is made before a specified deadline. For recipients, the early payment discount means savings, while for Suppliers, it ensures financial liquidity and reduces the risk of nonpayment and delayed payments
Early payment discount is beneficial for both parties, influencing better business relationships and business growth.
Verbal agreements regarding discounts are not acceptable. It is important to include all information about discounts on the invoice.
If the discount was not previously applied to the invoice, but an early payment was made, and the recipient committed to providing a discount, they must issue a corrective invoice. This is not necessary if the payment was made before the invoice was issued or if the payer does not meet the discount conditions.
Transactions with early payment discount should be settled in the appropriate settlement period, i.e., the one in which the payment with early payment discount was made.
The net invoice amount should be reduced by the early payment discount, and VAT should be calculated based on this reduced amount.
Take advantage of our pricing services now!
🧮 How is Early Payment Discount calculated? 🧮
How is early payment discount calculated? We’ll present various types of discounts, such as fixed discounts, volume discounts, and dynamic discounts. The process of calculating the discount value will also be explained, along with an example calculation.
There are different types of discount rates. Fixed discounts are predetermined percentage discounts that Customers receive for making payments before a specified payment deadline. Volume discounts, on the other hand, involve larger discounts that increase with the speed of payment after issuing the invoice. Dynamic discounts are calculated individually for each Customer, depending on various factors such as payment history.
The process of calculating the discount value involves multiplying the invoice amount by the percentage discount and rounding the result to two decimal places.
For example, if the gross invoice amount is 1000 PLN, and the discount percentage is 2%, the early payment discount value is 1000 PLN * 2% = 20 PLN. Therefore, the amount to be paid is 1000 PLN – 20 PLN = 980 PLN.
Volume and dynamic discounts have advantages compared to fixed discounts. Volume discounts encourage Customers to pay bills on time because the faster they pay, the higher the discount. Dynamic discounts adapt to the specific needs and behaviors of the Customer, potentially building stronger business relationships.
Early payment discount amounts usually range from 1-5% of the gross invoice value.
⚖️ Early Payment Discount: advantages and disadvantages ⚖️
Prompt payment discount brings the following benefits:
✅ Improvement of cash flow in the company: When Customers choose to make payments before the due date, the company receives funds faster, enabling it to meet current financial needs, pay Suppliers and interest on time, and invest in business development.
✅ Improved profitability through reduced financing costs: Instead of relying on traditional financing methods such as bank loans or factoring, the company can use available funds from discounts, which is more cost-effective.
✅ Greater control over financial metrics: By utilizing early payment discounts, the company can plan cash flow in advance, identify further expansion opportunities, and control its finances.
However, there are also disadvantages associated with early payment discounts.
❌ Reduction of profits: When the company offers discounts, it receives less money for the products or services sold, potentially impacting profitability.
❌ Early payment discounts are optional: Some Customers may choose not to take advantage of this option, leading to payment delays and disrupting cash flow.
❓When is it worth offering an Early Payment Discount❓
An early payment discount is an offer that businesses give to their Customers, encouraging them to pay their invoices faster than the designated deadline. Often, the discount precedes the payment deadline, serving as an additional incentive for Customers.
However, businesses must consider several factors before deciding to grant an early payment discount.
Firstly, comparing the cost of the discount to the cost of a loan is essential to determine its financial feasibility. If the cost of the discount is lower than the cost of a loan, offering the discount may be financially beneficial for the business.
Secondly, the benefits of an cash discounts can contribute to achieving working capital-related goals. Businesses can improve their financial metrics, such as DSO (days sales outstanding), by reducing the average number of days needed to settle receivables.
Access to an early payment platform can streamline payment processes and allow businesses to build strong relationships with counterparts by offering discounts and rewarding them for timely payments. Additionally, Customers may value taking advantage of the discount, enhancing their loyalty to the business.
🏷️ Alternatives to Early Payment Discount 🏷️
Preparing to offer an early payment discount requires adequate financial resources. If a business is unable to independently provide a discount, there are some alternative solutions that can improve cash flow. These include factoring, invoice financing, and taking out a loan.
👉 Invoice factoring involves selling unpaid invoices to a factoring company. The factoring company immediately pays the business a specified amount, often around 80-90% of the invoice value. The factoring company then handles the collection of payments from Customers and retains a small commission. This method significantly improves cash flow but can be costly, especially for small businesses.
👉 Invoice financing secures a loan based on the value of outstanding invoices. A bank or financial institution provides a loan based on the value of invoices, allowing the business faster access to cash. However, the invoices serve as collateral for the loan, so the business must be confident that its Customers will pay those invoices on time.
👉 Taking out a loan, the funds of which can be used to cover the cost early payment discount of an early payment discount. A loan allows flexible cash flow management but comes with additional costs such as interest and loan servicing fees. The business must also consider whether it is ready to take on accounts receivable.
Depending on the financial situation, the priorities of the business, and the type of Customers, all these alternatives can help improve cash flow. It is essential to understand and assess the benefits and drawbacks of each method and tailor them to the needs of the business.
Summary
Introducing early payment discounts can be an effective tool to streamline the invoicing process. However, businesses should carefully consider the advantages and challenges associated with implementing such a program. Consultation with an accountant or financial advisor can be crucial in making the right decision and maximizing the benefits of early payment discounts.