Types of early payment discounts
Static discounting
In static discounting , you offer a set discount for early payment , regardless of how quickly the invoice is paid . This can be advantageous as it ’ s easy to understand and calculate , but can also limit your revenue if customers take their time to pay . For example : If you have the usual Net 30 payment terms , you might offer a 1 % discount if they pay in the first ten days .
Dynamic discounting
Dynamic discounting takes into account how quickly the invoice is paid , offering a larger discount the sooner it ’ s paid . This can encourage customers to pay quickly , as the discount gets larger the sooner they pay . For example : If you have the usual Net 30 payment terms , you might offer a 0.5 % discount if they pay in the first ten days , then a 0.25 % discount for payments in 11- 20 days , and so on .
To implement an effective prompt payment discount strategy , you will need to ensure your invoice and payment data is being carefully tracked . To do this , we recommend having a debtors automation system in place , if not , you can use free invoice tracking template for Google Sheets and Excel .
Impact of Offering Discounts to your business
From the seller ’ s perspective , the effect on revenue from offering an early pay discount needs to be weighed against the potential reduction in debtors carrying costs , bad debt and collection expenses . Seller ’ s also need to consider the cost to administer discounts .
Lower debtor ’ s Carrying Costs : These are simply the cost of financing your debtors . Assuming the supplier has a line of credit , the longer a customer delays payment the more interest the supplier has to pay the financial institution . Even if the supplier had no need for a loan , there is an opportunity cost for having the funds tied up in debtors as opposed to being available to invest in growing the business or becoming more
efficient . By instituting an early payment discount , you are motivating customers to pay more quickly , thereby accelerating debtor ’ s turnover and reducing the size of your firm ’ s investment in debtors , and resulting in lower debtors carrying costs .
Bad Debt Reduction : Accelerating customer payments with an early payment discount reduces your exposure to bad debts . While customers taking advantage of the discount are unlikely to default , your exposure to them will still be less than if they were paying slower - good paying companies do occasionally end up bankrupt . More importantly , offering an early pay discount helps you better identify those customers with adequate cash reserves ( the discount takers ) as well as those customers who are likely to have cash flow challenges ( those who don ’ t take the discount ). A buyer ’ s response to a discount is a powerful signal of its financial condition , because the high annual cost of not taking the discount is a penalty buyers will avoid if they can . By more carefully monitoring the customers that don ’ t take the discount , you can reduce your exposure to bad debts .
Less Collection Expenses : Lacking a prompt payment discount incentive , all your customers will pay near the due date or some number of days past due . A significant amount of collection effort is directed at customers that , though past due , tend to self-cure within 15-30 days . With a discount in place , a large segment of customers pay early , so there are fewer accounts that need to be monitored for going past due , thereby reducing the number of initial collection contacts you need to make . Along with the reduction in exposure to accounts that might default , the reduction in collection activities is an offset to the small percentage of sales consumed by the discounted terms .
Customer benefits
While getting paid on time does very much benefit your business , it is also important to remember the customer . Offering early payment discounts can help you win and keep customers by offering them benefits as well . Any discount on an invoice you send will improve the profit margins of your customers . This will make your customers more willing to pay on time , as you can offer them a discount incentive . Offering an active reward for good payment behavior also shows that you value your customers and their business - a gesture that is sure to be appreciated .
All said and done early payment discounts are a way to reward good payment behavior , functioning as the carrot , where late payment fees are the stick to discourage poor payment behavior .
Wasilwa Miriongi is a Certified Credit Professional currently working as the Managing Director , Del Creder Credit Management Limited . You can engage him on this or related matters via email at : WMiriongi @ gmail . com .