Early Payment Discount Reasons to Offer, Accounting, & More

Eric is a staff writer at Fit Small Business and CPA focusing on accounting content. He spends most of his time researching and studying to give the best answer to everyone. With a discount of 3%, the customer would owe $485 rather than the original invoice amount of $500. Not every opportunity for an early payment discount is used successfully – for internal or external reasons.

A prompt payment discount is a way to save money that doesn’t require the business to do anything except what they’re already doing – paying vendors. Suppose Paul’s Plumbing invoices a customer for the installation of a new bathroom and sink faucet for $1,000. The term for the early payment discount is 2%/10 Net 30, so if you receive payment in 10 days or less, the invoice will be reduced to $980. If the customer pays after 10 days, they must pay the full $1,000. The screenshot below shows how this payment term is displayed on an invoice from QuickBooks Online. A common early payment discount set-up is expressed as ‘2/10 net 30 days’.

• The idea behind dynamic discounts is the flexibility to offer a discount rate that makes sense for your business rather than accepting a static rate from customers.
• By selling receivables, you’re transferring to the factor the rights to collect the amount due from your customers, plus you agree that certain fees will be deducted.
• Especially when it comes to vendor relationships and business transactions.
• The discount a vendor offers will vary based on several factors.
• The longer a business waits to get paid, the more risks there are involved.
• Customers, on the other hand, might miss a chance to apply EPD due to invoice processing delays.

They have to have the money ready earlier and complete the logistical tasks of doing so, but they don’t pay an added fee to a third party like they do with commercial-based lending. However, the buyer should be absolutely sure of their capacity to pay earlier. Causing a budget overdraft to qualify for the early pay discounts can result in fines elsewhere. With 2% 10 net 30 as a fixed EPD, no discount will be applied if the invoice is paid on the 11th day. A fixed EPD is a non-flexible addition to the standard payment terms of an invoice. Discounts can be claimed only under specified conditions or not at all.

Fixed

However, using discounts instead of factoring is only possible if your customers already support an early payment program. Factoring agreements also tend to be confusing and written to keep you locked in. But as long as your customers offer early payment programs, you can use both — and you’ll likely save more money than using factoring alone. Adding discount terms to a pay cycle benefits both the vendor and the customer. Not only does it assist with cash flow problems, but a company can also avoid late payments and strengthen business relationships. This means your business still has to pay for employees, expenses, and overhead.

Additionally, early payment discounts might not suit your business if you already have a reliable cash flow or access to alternative funding options with lower costs. However, there are some disadvantages of early payment discounts. Offering discounts cuts into your profits (though the benefits of early payment are often still worth it if your business has tight margins). If you opt for static discounts, customers may also take advantage of static discount terms attached to an invoice, deducting the discount without actually paying early. Before offering customers an early payment discount, consider your profit margin.

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Dynamic discounting is an early payment program that allows for flexibility in business transactions and efficient response to supply and demand. If you’re unfamiliar with this alternative, our article on A/R financing discusses costs, terms, qualifications, and more. You can also see our guide on the best invoice factoring companies for our recommendations. Receivable factoring may not be an affordable option, but it can be a solution to recover overdue accounts. Factoring will deduct a factoring fee and factor’s holdback from the total amount of receivables factored. Hence, you’ll not receive the total amount of receivables factored, but it can help you recover cash for working capital needs.

Reasons to Use Dynamic Discounting Instead of Your Business Line of Credit

Through it, you’re offering a sliding-scale discount without pressuring them to pay within the fixed discount period. If a buyer’s primary objective is to reduce cost of goods sold (COGS), then early payment discount programs can be helpful in achieving that objective. Dynamic discounts give you the flexibility to offer a discount rate that makes sense for your business rather than accepting a static rate set by your customer. Some early payment programs offer additional products that give you more control over your rates and discounts. Static discounts give your customers more control over when to pay you early, which has several drawbacks.

If giving early payment discounts won’t work for some customers, you can try alternatives that can help maximize your finances without compromising your healthy relationships with them. Offering early payment discounts can help speed up invoice collection. Our small business bookkeeping guide teaches you all essential bookkeeping responsibilities you should know. To calculate early payment discounts, multiply the total invoice amount by the discount percentage. Next, subtract the discount amount from the total invoice amount to get the payment due on the invoice. To record the customer’s payment, debit your Cash account and credit your Accounts Receivable account.

Additionally, by granting the customer an EPD, the vendor increases their chances of receiving payment on time and reduces the risk of late payment or non-payment. The earlier the customer gets the incentive to pay, the smaller the risk. Dynamic discounting works by providing a discount throughout the credit period. However, customers can get a higher discount if they pay earlier or a lower discount if they pay later.

Nor does this approach give suppliers any certainty that their customers will take advantage of the early payment discount on offer. For example, a supplier may offer two discount tiers based on when the buyer chooses to pay. The first tier may be a term of 2% 10 Net 30, meaning the buyer can deduct 2% from the invoice price if they pay by day 10.

Solutions

The second tier may be 1% 20 Net 30, meaning the buyer can deduct 1% from the invoice price if they pay by day 20. This gives the buyer the flexibility to choose which discount tier to select based on when they decide to pay their supplier. Instead of giving a fixed discount rate for a certain number of days, you can offer dynamic discounting to provide a win-win situation between you and your customers.

Brianna Blaney began her career as a fintech writer in Boston for a major media corporation, later progressing to digital media marketing with platforms in San Francisco. She has worked as a financial writer for Tipalti for 7+years, keeping a close eye on shifting trends and reporting on the ever-evolving landscape of financial automation. She prides herself on reverse-engineering the logistics of successful content and implementing techniques centered around people (not campaigns). In her spare time, she loves to cook and take care of her pet squirrel, Marshmallow.

• There’s usually a generally acceptable set of discount terms for each particular industry.
• Factoring will deduct a factoring fee and factor’s holdback from the total amount of receivables factored.
• Suppose Paul’s Plumbing invoices a customer for the installation of a new bathroom and sink faucet for $1,000.
• If they extend it to you, it puts your business in control of when to offer a discount and receive payment.
• As borrowing costs rise, more companies are looking to access funds trapped in operations.

As borrowing costs rise, more companies are looking to access funds trapped in operations. They are negotiating longer payment terms, prompting customers to pay sooner, and shrink inventories to conserve working capital. It’s up to the involved parties to decide on the terms for the EPD. However, there is a suggested 2% discount if an invoice with thirty days maturity is paid within ten days. Also known as commercial-based lending, this method gives buyers the advantage of prompt payment discounts without the extra task of having to pay early.

Five Steps to Secure a Prompt Payment Discount

To start, this option is often less convenient and predictable for you. Customers may also take advantage of alternative credit terms and get discounts without actually paying early. This means that your accounting team will likely spend more time tracking payments to make sure customers are complying with the terms. Plus, you might find you need to raise your prices to offset the extra cost, which might make your prices less competitive. Again, offering a discount for prompt payment can encourage customers to pay their bills early, boost cash flow, and strengthen relationships. If you offer credit to your customers, you likely send an invoice that details when payments are due, how to pay them, and more.

However, this type of arrangement lacks both certainty and flexibility. The urgency of your cash flow situation can also influence when it makes sense to request an early payment discount. If you need working capital right now, find out if any of your customers use C2FO’s Early Payment platform so you can request early payment today.

This can positively impact their working capital position, providing access to the extra working capital needed to fulfill customer orders or grow the business. An early payment discount is a form of trade finance, allowing buyers to pay a discounted amount to suppliers in exchange for settling invoices before their maturity date. Also known as a prompt payment discount or early settlement discount, it’s typically calculated as a percentage of the goods and services purchased. To return to the example of 2/10 net 30 terms, if the buyer pays the invoice within 11 days instead of within 10 days, they will not be able to access any discount at all. This can make it difficult for some buyers to take advantage of early payment discounts, particularly if manual processes are used to handle invoices.

Debit your Cash account to increase it and credit your Accounts Receivable account to decrease it. If a customer pays within 10 days on a 2/10 term, the early payment discount is $20. This means if the customer is invoiced monthly, they save an average of $240 over the year.

Factoring is basically “selling receivables” to a factor, or buyer of receivables. By selling receivables, you’re transferring to the factor the rights to collect the amount due from your customers, plus you agree that certain fees will be deducted. Early payment discounts have benefits for both vendors and customers beyond the obvious one of saving the customer money. Traditionally, early payment discounts are initiated by the supplier, which will offer discounts to customers when invoicing for goods or services.

He completed a Bachelor of Science degree in Accountancy at Silliman University in Dumaguete City, Philippines. Before joining FSB, Eric has worked as a freelance content writer with various digital marketing agencies in Australia, the United States, and the Philippines. The discount a vendor offers will vary based on several factors.