Many businesses invoice their customers, allowing them to pay for goods and services in 30-90 days. Because many small businesses need cash sooner rather than later, early payment discounts of up to 2% can be provided as an incentive. In this article, we will discuss what vendors and customers need to know about early payment discounts.
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How Early Payment Discounts Work
An early payment discount (also called prompt payment discount or cash discounts) reduces the amount of money that the buyer owes the seller if the buyer pays before the due date noted on the invoice.
Early Payment Discount Example
Say you are a buyer and receive a $1,000 Net 30 invoice. If you pay the invoice within 10 days of receiving it, you may be able to deduct 2%, or $20, from the payment. On the invoice, these terms would be noted as 2%/10 – Net 30. In other words, if you pay in 10 days or less, the invoice can be settled for $980 instead of $1,000. If you pay after 10 days, you must pay the full $1,000.
How Much of a Discount A Seller Should Offer
The discount a vendor offers will vary based on a number of factors:
- What’s standard in the industry?
- Are the seller’s competitors offering early payment discounts? If so, how much?
- Has the client paid on time in the past?
The most common terms that vendors extend to their customers are:
1%/10 – Net 30
This means the customer can deduct a 1% discount if they pay within 10 days. If the customer does not pay within 10 days, then the invoice is due in 30 days with no discount. Use this payment term to incentivize those customers who never seem to pay their invoices on time.
1%/15 – Net 30
This means the customer can receive a 1% discount if they pay within 15 days. If the invoice is not paid within 15 days, then it is due in 30 days.
2%/10 – Net 30
This means the customer can receive a 2% discount if they pay within 10 days. If the invoice is not paid within 10 days, it is due in 30 days with no discount. It’s beneficial to offer a 2% discount for jobs that required a large outlay of cash that you need to recoup quickly.
2%/15 – Net 30
This means the customer can receive a 2% discount if they pay within 15 days. If the invoice is not paid within 15 days then it is due in 30 days with no discount.
If it’s industry standard to offer discounts or your competitors are offering them, then you may be doing yourself a disservice by not offering a discount. You should match your discount to your industry standard or your competitors’ terms, unless you offer some other advantage to customers (e.g. faster shipping or lower base prices).
Your client’s payment history will also come into play. If you have a customer who already pays early, there may be no reason to offer them a discount. On the other hand, if your customer habitually pays late, this may incentivize them to pay early for a change.
Benefits of Early Payment Discounts
Early payment discounts have benefits beyond the obvious one of saving the customer money:
Benefits for Vendors
There are several reasons why a vendor would offer early payment discounts:
- Get paid sooner.
- Reduce the risk of nonpayment or late payment by the buyer by getting paid sooner. The longer you wait to get paid, the more things that can happen that may prevent the buyer from satisfying its obligation.
- Increase working capital and reduce gaps in cash flow by shortening the lag time between invoicing and receipt.
Benefits for Customers
Here’s how a customer can benefit from early payment discounts.
- Save money! The discounts add up over time to save you a significant amount of money, particularly if several of your suppliers offer the discounts.
- Build business credit – By paying your bills early, you can increase your business credit score.
- Build relationships with vendors – The sooner you pay a vendor what you owe, the more likely that vendor will be to work with you in the future.