Types of Dynamic Discounting: Unlock Your Cash Flow Now (Part 3)
[Click here to read “Dynamic Discounting 101 & Why Should You Care: Unlock Your Cash Flow Now (Part 2)”]
The Need for Dynamic Discounting
The SME sectors of India are facing a debt gap of at least Rs.2.93 trillion, according to a report by the International Finance Corporation. While 98% of Indian businesses extend credit to their clients, 97% of them are paid late every year.
By the end of 2015, 14% of the total unpaid B2B accounts receivables were found to be still unpaid after 90 days or more past the due date, which was much higher than the 10% average for the Asia Pacific region.
It was also significantly higher than the same statistic at the end of 2014, when only 6.1% of receivables had still been pending at the end of 90 days. This shows a 2.3x rise in the number of accounts receivables going unpaid in India past 90 days in the span of a single year.
The implication is clear. With the cash hoarding crisis on the rise, larger companies are displaying a rise in willful default behavior.
Thus, suppliers have to switch up their payment collection SOPs as well, and provide greater incentive for their buyers to pay them on time.
This is where Dynamic Discounting comes in.
Types of Dynamic Discounting
Since Dynamic Discounting is part of those business mechanics which seem simple on the surface, and yet are highly nuanced, we’ve provided a deep-dive into the practice here for our readers & visitors.
This is particularly crucial since research suggests that while 80% of companies place emphasis on capturing early payment discounts, only 27% of them are able to leverage technologies to capture available discounts.
Moreover, 46% of buyers are only able to capitalize upon 1-10% of discounting terms made available to them. In fact, 27% of buyers state that while they wish to pay their supply chain faster and avail the discounting offers made available, their company’s lengthy approval cycles cause them to miss out on such opportunities due to the static discounting methods normally employed.
Therefore, integrating Dynamic Discounting into your payment models is as fiscally attractive to you as it is to your buyers.
So, caught up with our last article yet? Awesome. Let’s jump into the common variants of Dynamic Discounting, and find one that works perfectly for your business.
Multiple Discounting Terms
Now to clarify, this does not mean that there are different base terms negotiated for varying periods between buyer and seller. Using the base Annual Percentage Rate (APR) agreed upon between the transacting parties, the seller provides discounting opportunities across multiple time periods within the net term.
As an example, in static discounting, a seller may provide their buyer with 1.6%, 14, Net 30 terms. This means that if their buyer clears the accounts receivables due by Day 14 from the day of invoicing of a 30 day payment period, they receive a 1.6% discount on that particular invoice.
In such a case, if the buyer is ready to pay by Day 7 from the date of invoicing, they would still wait till Day 14 since they have no incentive to pay earlier in order to avail of benefits, and yet all the reasons conceivable to hoard their cash till the last moment.
Furthermore, if the buyer can’t pay by Day 14 and yet can clear the receivables by Day 15 itself, they would still wait till Day 30 since they receive no benefits from paying early once the static discounting date is crossed.
However, this variant of Dynamic Discounting provides several options within the net payment term for the buyer to clear their receivables with varying levels of benefits.
In such a case, let’s take for example that the Annual Percentage Rate agreed upon between buyer and seller is 24%. The seller then may provide a discounting period from Day 2 to Day 10 on a sliding scale, with additional discounting dates on Day 15 and Day 20 in case the buyer can’t capitalize upon the first discount period.
Particularly, the seller will state that the scale of discount from Day 2 to Day 10 will range from 1.84% to 1.31% respectively, adjusting each day according to the formula [(ARP/365)*Days Remaining Till Due Date]. And the discounting on Days 15 and 20 will be 0.98% and 0.65% respectively.
This means that if the buyer requires more time than Day 10 to approve the invoice, they still have an incentive to pay on Day 15. Further, if they are facing liquidity issues on Day 15 for example, they can still avail some benefits by paying on Day 20.
Since the calculation of benefits is limited to specific time periods and provided to the seller by the buyer, this allows buyers and sellers to engage in Dynamic Discounting even without expensive ERP suites to track the same.
This method, while not strictly true Dynamic Discounting, leverages the same principles to deliver multiple periods of discounting within the net payment term. In the absence of automation of AR/AP processes, this still provides buyers with more incentive to pay before the entire payment period is over than the static discounting terms.
Dynamic Payment Terms
This variant represents true Dynamic Discounting, and is usually implemented with the help of ERP suites or third-party platforms.
However, such third-party services are only utilized for the convenience of automation and ‘dashboard’ functionality. The terms of Dynamic Discounting can be manually calculated and communicated with ease between buyers and sellers as well.
Dynamic Payment Terms utilize the agreed-upon APR and provide a sliding discount to the buyer over the entire payment term, rather than limited periods as seen in the previous variant.
Thus, with an APR of 24% and Net 30 payment term for example, the buyer can pay instantly after the invoice has been approved and liquidity issues sorted regardless of the date.
So, if the payment is made on Day 9, the buyer will receive a discount of 1.38%. Going up or down along the sliding scale, the discount would be 1.57% on Day 6, 1.18% on Day 12, 1.11% on Day 13, and so forth right up till 0.06% on Day 29.
Dynamic Discounting Part II: In Closing
This article, as well as the previous one in our series on Dynamic Discounting, should make the need for such payment practices perfectly clear. But more importantly, it should also underline that Dynamic Discounting is not just the name for a practice or service provided by third-party enterprises and products, but rather a principle.
Dynamic Discounting was born out of the necessity for suppliers to be paid on time by their buyers in a world where cash hoarding by mid-sized or larger corporates is quickly becoming the norm. But it also leverages upon potential individual benefits for both the buyers and sellers in order to be as attractive a payment practice as it has shown itself to be.
So, whether you need to implement this principle manually into your payment recovery models, or you call upon the services of a third-party platform to do the same, your take-away from us should be – implement it at all costs if you hope to remain among the 50% of companies which survive their first five years, rather than those who don’t.
Think we’re being alarmist? I wonder what the 33,000 SMBs shutting doors every year in the United States or the 22% of registered SMEs which have closed down in India between 2007 and 2012 would have to say about that.
So, let us know in the comments section below – what have your experiences with Dynamic Discounting been like? Have there been any other variants of the same which you’ve implemented in your payment recovery practices?
In the meanwhile, Hummingbill takes care of all the other reasons you get paid late, from automated reminders to error-free, 1-click, e-invoices made in Gmail. So, sign up today for a free account with Hummingbill, or join the 14-day free trial with access to all of our advanced features.
And take a moment to sign our Change.org petition and join the hundreds of businesses calling upon the Government of India to implement more practical late payment protections than the ones in place at the moment.
- Aniket Saksena and Adam Walker