07/05/2021Budgets & Other
Early payment discount is also known as prompt payment discount. It is the early settlement discount buyers receive in exchange for paying invoices early. You can calculate it as a percentage of the value of the goods and services purchased.
An early payment discount is a process to improve cash flow for suppliers by fast customer payments that reduce the days sales outstanding (DSO). It positively impacts the supplier’s working capital position. It provides reach to the funds required for customer orders or expand the business.
If you’re a buyer, early payment discounts mean that you’re going to get a lower cost of goods. These discounts might show an ample return on the company’s cash. Through the early payment discounts, buyers can make better and stronger relationships with their suppliers.
Early Payment Discount – Example:
Commonly EPD is written as 2/10 net 30 days. It implies that the invoice contains a 30 days deadline. Here is an advantage for the buyer if he pays the seller early. A 2% discount is provided to you if you pay the invoice within 10 days. For example, if you were going to pay a $1000 invoice, in normal 30 days your pay the whole amount whereas if you pay it within 10 days you’ll get a $20 discount from the total amount.
For a buyer, these savings are considered a favourable return. To calculate the cost of credit here’s the formula:
- Discount %/(100 – discount %) x 360/(Full allowed payment days – discount days)
So for 2/10 net 30 terms, the cost of credit is calculated as follows:
- 2/(100-2) x 360/(30 – 10)
= 2/98 x 360/20
A company buying goods, 2/10 net 30 days shows a great return on cash of 36.7%. At the same time, the discount weights the same as a high funding cost from the supplier’s perspective.
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Using Dynamic Discounting for Early Payments Discounts:
Unlike traditional discounting, the buyers can benefit from dynamic discounting by making the buying system more flexible. With dynamic discounting, buyers allow their suppliers to take the payments on their invoices against a discount. In this way, buyers receive the discounts any time after the approval of the invoice and maturity date. The value of the discount will depend upon how earlier the buyer pays the invoice.
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Benefits of Dynamic Discounting:
EPD achieved by dynamic discounting is beneficial for both buyers and suppliers. The supplier receives the money before the time, hence it enhances their working capital position. While buyers pay less amount than normal circumstances. These are some benefits of dynamic discounting:
- You can get cash whenever you want due to different reasons
- You can predict cash flows due to the knowledge of accurate payment time
- Investment opportunities in R&D and for business growth
- Getting a less costly funding option than other financing options like factoring
- Saving options for goods and services
- Get return without the fear of risks on surplus cash at a higher rate compared to traditional investments
- A stronger relationship with the supplier
- Bringing down the risk of supply chain disruption
Quick Wrap Up:
Early payment discounts are both beneficial for the buyer and the seller. It’s a win to win game.
Early payments discounts not only enhance the process of cash flow, but a business can avoid late payments and make a stronger relationship with its supplier. As a whole, it produces additional working capital for the business progress.
You can use accounting software like QuickBooks, Xero to create invoices with early payments discounts. You can make the payment terms flexible for the customers by using the above information.
Disclaimer: This blog is written for general information on EPD.