4. Early Payment Discount

Definition

Early Payment Discount or Prompt Payment Discount is a method of trade finance wherein vendors offer their buyers a discount on outstanding invoices as an incentive to pay early.

This is apparently a win-win arrangement, securing cost savings for the buyer via accounts payable and more ready cash on hand for the supplier via accounts receivable.

Suppliers who offer early payment discounts to their buyers can set controls on when discounts trigger and the amount offered, leaving buyers to choose whether to capture savings or hold onto their cash a little longer.

How does it work?

Early payment discount terms can take a variety of forms depending on supplier preference and the credit terms and pricing negotiated. Three of the most common options are static discounting, sliding scale discounting, and dynamic discounting.

Static Discounting

A simple modification to negotiated credit terms. For example, if an invoice has the terms “2/10 – net 30”, it means the customer has 30 days to pay the full amount due but can deduct 2% of the total amount if the vendor will receive a payment within 10 days instead.

Consider this example: You receive a ₹10,000 invoice from a vendor and the terms are 2/15 – Net 30. You decide to pay within 15 days, and issue payment for ₹9,800 (₹10,000 – (10,000 x .02) = ₹9,800).

Sliding Scale Discounting

This method doesn’t have a specific discount period but ties discounting to the actual pay date. With sliding scale discounts, the customer pays an amount based on a fraction of the offered discount.

So for an invoice with 2/10 Net 30 pricing, a sliding scale might look something like this:

Dynamic Discounting

Dynamic discounting is a solution that enhances a buyer’s profitability by reducing its Cost of Goods Sold (COGS). Dynamic discounting gives the buyer’s vendors the flexibility to choose when they would like to get paid in exchange for a reduced price on the goods and/or services purchased. The “dynamic” component refers to the option to vary the discounts based on the dates of payment to suppliers. In most cases, the earlier the payment is made, the greater the discount.

Early Payment Discount Benefits

For buyers, the appeal of securing immediate cash savings can be very compelling, especially if they have sufficient cash on hand to pay the full invoice amount early without causing cash flow problems.

Paying invoices on time or in an early payment discount period helps establish and protect business credit. The better your credit, the more welcoming you will find new suppliers, investors, and lenders.

They’ll also build stronger relationships with their suppliers. This can open the door to even more favorable credit and payment terms in later negotiations, as well as opportunities to collaborate in mutually beneficial ways (e.g., product development, exploration of new materials, shared investment initiatives in technology, etc.).

For suppliers, customers who take advantage of the early payment discount terms can be a reliable source of cash that helps eliminate gaps in their working capital. Offering early payment discounts in tandem with electronic invoicing (eInvoicing) can also reduce invoicing costs. It minimizes the need to tighten inventories or seek alternate sources of funding such as invoice factoring that provide immediate cash but prove much more costly in the long run.

Early Payment Discounts for Savings and Value Addition

From managing cash flow effectively to building a stronger bottom line, a cash discount from a supplier—or an early payment from a customer—can make a powerful difference. To realize the full value offered by early payment discounts, make sure you have a clear understanding of what’s on offer, have hammered out the details in writing with your suppliers, and are ready to strategically balance your cash flow needs against the potential savings to be gained. You’ll have the working capital you need for growth and innovation while still saving money and meeting your obligations, and build stronger relationships with your suppliers at the same time.