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The Truth About Early Payment Discounts

Topics: Finance, Management

Early Payment Discounts offer a discounted rate to companies who pay their invoices early. As a vendor, you define how many days early any discount will be applied. For example, you might send out an invoice with the following terms:

2/10 - net 30

The above is a net 30 invoice with a 2% early payment discount if paid within 10 days rather than 30. 

We're going to look at the customer and vendor perspectives, both good and bad. We'll dig into what can happen when things don't go quite right and also cover a number of considerations when deciding to use early payment discounts.

Customer Benefits of Early Payment Discounts

Benefits to customers are clear in that they receive an immediate discount by paying on your early discount payment terms. If an invoice is $1000 and the customer pays within 10 days on a 2/10 term, they will receive a $20 discount. This results in the invoice dropping to $980.

Assuming the customer gets a $1000 invoice each month with 2/10 - net 30 terms, they can save $240 across a year. Quite an appealing incentive.

Additionally, paying invoices on time and early can help a customer's business credit. This can lead to improved terms when working with existing and new vendors.

Vendor Benefits of Early Payment Discounts

For vendors, getting paid early improves cashflow. With net 30 and especially net 90 terms, cashflow can be crimped. Meaning, the business still has to pay for overhead, expenses, and employees. As invoice payments are pushed out further into the futures (i.e., net 90), cash in the bank dwindles as its eaten up by operating expenses.

Getting companies to agree to a 2/10 or 1/10 term helps replenish cash and can keep it from dropping to extreme levels.

With improved cashflow from early payments, you are also improving availability of working capital. This decreases the chances of having to find external sources to fund working capital.

The longer you wait to get paid, the more risks you take in not getting paid. Offering an early payment discount can help put you ahead of other vendors and reduce the risk of not getting paid.

Discounting Considerations

While the above seems to be a win-win situation for both the vendor and customer, there are a few considerations vendors must take in.

  1. Can you absorb the discount? A 1% or 2% discount may not seem like much but if your business operates on thin margins, these small discounts can add up and cut even further into profit.
  2. Even when a customer agrees to pay early, taking advantage of the discount, you might not get paid until after the discount due date. This of course defeats the purpose of the incentive while also discounting the total amount you receive at no advantage to you.

When a customer doesn't pay on time but still sends you the discounted invoice amount, things can get tricky.  Speaking with a human and reminding them about the deal you both have in regards to payment discounts might help. Second is to send an email to someone you've already been in touch with at the company and ask them to intervene for you.

Sometimes a 10 day discount simply isn't possible for customers. Which customers will depend on the specific business. You might consider offering discounts around the 15 or 20 day mark. You can start with 15 and see what kind of response you get. If that isn't working, try 20.

Also be aware of what is normal in your industry. If your competitors aren't offering early payment discounts and customers are use to paying net 30, net 45 or net 90, it might be a hard sell getting them to pay within 10 or 15 days.

Having your early payment discount terms in writing (even email) can go a long way to resolving issues that will inevitably arise when customers don't pay on time but take the payment discount anyway. A written agreement will also come in helpful if your contact at the customer company happens to leave.

Are Early Payment Discounts Right For Your Company?

Early payment discounts can help improve a vendor's cashflow while also pleasing customers. This assumes the environment is right for shorter, outstanding invoice terms.

Having your payment discount terms in writing can go a long way to resolving conflicts. Ultimately, putting the option out there and testing different scenarios (discount rate, net days) will help you determine how receptive your customers are to early discounts and what changes if any need to be made.

Net terms accounts receivable

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