Many companies give credit to their customers. At times this may cause a cash flow problem if the customers want to extend their credit beyond the time set. By offering an incentive to the customers, it may be possible to get them to pay sooner. This is done by offering the customer a discount on the amount owed if they make the payment within 10 days. Usually a 1% discount is offered to the customer on his outstanding for making the payment in 10 days.
This can be advantageous to both the company giving credit as well as the customer. By paying the invoice early the customer gets a 1% discount on the amount owed which in the course of a year amounts to an 18% savings. At the same time the company giving the discount gets an inflow of cash much quicker which can help its cash flow.
A company may decide to give its customers a larger discount on a sliding scale if it needs its customers to pay and benefit at the same time. For example a company may offer a 5% discount if the customers pays within 6 days. A 4% discount if he pays in 7 days, a 3% discount if he pays in 8 days, a 2% discount if he pays in 9 days and a 1% discount if he pays in 10 days. For a customer who has ready cash, this can be a big incentive as he could save much by paying early and availing of the discount.
The early payment discount is an easy way for a company to shorten its billing cycle. By shortening its billing cycle the company is in a position to improve its cash flow which is always a good thing. The customer too can benefit by the early discount since he stands to save much by making early payments. Even if a customer does not have a credit line or cash to avail of the discount the early payment discount may be small as compared to bank overdraft charges.
Every business tries to reduce its costs and save as much as possible, by availing of the early payment discount that is offered by vendors a business can save and reduce its procurement costs. At the same time a company that offers an early payment discount may find that it saves on the interest costs for the credit that it offers its customers.
The early payment discount is also sometimes referred to as the prompt payment discount or the cash discount. This discount is sometimes known as a sales discount by the seller and as a purchase discount by the buyer. In the world of business these discounts are of importance to both the buyer as well as the seller as they help both the parties save in terms of interest or a reduction in the sales price. They are a form of incentive to both the buyer as well as the seller helping them maintain a healthy business relationship.