Business Benefits of a Prompt Payment Discount

Offering a prompt payment discount offers businesses many advantages. From a supplier’s point of view, it helps to eliminate late payments and keep cash flowing, making it easier to keep up with supply chain demands. Customers also benefit by having lower order costs.

In this post, we discuss some early payment discount advantages and look at how to account for early payment discounts.

What is a prompt payment discount?

A prompt payment discount is a trade finance deal whereby a buyer pays less than the full invoice amount for paying a supplier earlier than the invoice maturity date. It’s typically calculated as a percentage of the value of goods and services purchased.

A prompt payment discount is also known as:

• An early payment discount

• An early settlement discount

• A cash discount. 

There are various ways of applying a prompt payment discount. Here are two early payment discount examples:

Static discounting

Here, a company offers pre-defined early payment terms to a supplier. The early payment terms can be selected at the time the invoice is created.

For example, 1% 10 net 30 days – where the buyer takes a 1% discount for paying within 10 days.

Discount tiers

This approach is better suited to smaller suppliers and offers a buyer the option to pay an invoice early based on discount tiers. It is an approach also known as dynamic discounting For example, a supplier may offer two tiers as follows:

• 2% 10 Net 30: A buyer can deduct 2% of the invoice price if they pay by day 10

• 1% 20 Net 30: The buyer can deduct 1% of the invoice price if they pay by day 20

This allows the buyer flexibility over when they pay, depending on which discount suits them best.

Early payment discount advantages

Here are some of the main early payment discount advantages:

• Protects the supply chain: Offering a prompt payment discount helps to ensure suppliers can improve their cash flow management so they have sufficient liquidity to keep stock moving.

• Reduces the need for funding: An early payment discount helps suppliers with their financing. When managed well, suppliers can reduce their reliance on funding and instead use their increased cash flow to expand their business – or pass liquidity benefits on to their own suppliers. When interest rates are high, this offers especially significant advantages.

• Reduces risk: Early payment discounts mean a lower cost of goods for customers, which represents a good return on that company’s cash. A prompt payment discount helps a supplier to build better relationships with suppliers, reducing the risk discount of being paid late or not being paid at all.

As we’ve already noted, one of the chief early payment discount advantages is being paid faster. Companies can also ensure they get paid promptly by using a payment processing service like GoCardless. GoCardless collects invoice payments directly from a customer’s bank, via direct debit, and gives companies advance notice of incoming payments – and of customers who haven’t paid.

The disadvantages of an early payment discount

Although offering an early payment discount often results in you getting paid faster it is not without downsides. The following are some of the disadvantages of a prompt payment discount:

Tight Margins - if your business already ruins on very tight margins then the prompt payment discount you have to offer could knock a damaging amount off any profits you make 

Late Payments - in some cases customers take the prompt payment discount up-front but then still don’t actually pay until the standard due date. If this happens repeatedly the pressure on margins will be such that it may not be worth persevering with the prompt payment discount.

Extra Admin - if you still handle your invoices manually then the process of offering and applying a prompt payment discount, then tracking the invoice to ensure that the payment comes in quickly enough could create a lot more paperwork.  

How to account for early payment discount

A prompt payment discount is VAT inclusive, so it reduces the amount of VAT that is paid or reclaimed. To make a record of this, a credit note can be used to indicate the amount of discount offered. The early bird discount can only be applied when payment is actually received within the early payment timeline that’s been offered.

As we see, there are many early payment discount advantages, from increasing cash flow to avoiding supply chain disruptions. However, paying invoices early could negatively impact a customer’s cash flow – especially if they have lengthy payment terms with their own customers. When introducing a prompt payment discount, it makes sense to work with suppliers with a healthy profit margin, who are able to absorb the discount. 

We can help

GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Offering a prompt payment discount to your customers to your customers the automated nature of our systems makes invoices and payments much easier to track.On average, UK SMEs are paid 18 days late, and working with GOCardless could make all the difference.Find out how GoCardless can help you with one-off or recurring payments.