Early payment discounts allow buyers to pay a reduced amount to suppliers in exchange for early settlement of invoices before their due date. Also known as prompt payment or early settlement discounts, they are usually calculated as a percentage of the purchase amount.
While early payment discounts can benefit both buyers and suppliers, they also come with some drawbacks. This guide examines the key pros and cons of early payment discounts to help businesses make informed decisions.
Pros of Early Payment Discounts
Improved Cash Flow
Getting paid early improves cash flow for suppliers by expediting customer payments. This reduces the number of days sales are outstanding and enhances working capital availability. Suppliers can use the extra capital to fulfill orders, maintain operations and fund growth.
Lower Cost of Funding
For small suppliers, early payment discounts offer an affordable financing alternative compared to options like commercial lending which have higher interest rates. Suppliers also avoid late payment risks and associated costs.
Strengthened Buyer Relationships
Offering early payment discounts, especially through dynamic discounting programs, builds stronger ties with buyers. This can potentially translate into more business in the future.
Reduced Cost of Goods
Early payment discounts allow buyers to pay less than the full invoice amount. For a 2% early payment discount on a $10,000 invoice, the buyer saves $200. These savings directly reduce the cost of goods sold.
Settling invoices before due dates generates returns similar to short-term investments for buyers. For instance, a 2% discount on a 30-day invoice roughly translates into a 36% annual return on the early payment.
Improved Supplier Relationships
Making timely payments and availing early discounts builds trust and reliability with suppliers. This ensures stability in supply chains and operations.
Better Negotiation Leverage
Buyers who consistently make early payments can negotiate better deals, pricing and payment terms with suppliers in the long run.
Cons of Early Payment Discounts
Offering early payment discounts means suppliers receive less revenue per sale. A 2% discount on a $10,000 invoice would mean forfeiting $200 in revenue.
Managing early payment discount programs involves additional time and costs related to accounting, tracking invoices and monitoring collections.
Under traditional discounting, buyers may not always avail of early discounts offered on invoices. This makes revenue forecasting difficult for suppliers.
Strains Cash Flows
Availing early discounts may strain cash flows for buyers, especially if negotiated payment terms are already maximal. Paying earlier than required needs careful planning.
More Working Capital Needed
Buyers have to ensure adequate working capital availability to make payments before due dates. Otherwise, benefitting from early discounts becomes difficult.
The accounting and treasury team may need to put in additional work to track invoices and make payments while availing discounts. Existing systems may require upgrades.
Limits Negotiation Power
If buyers become dependent on early payment discounts, suppliers may limit negotiated terms and pricing. This reduces buyers’ leverage in the long run.
- Weigh reduced costs against revenue losses and cash flow impact.
- Assess if adequate working capital and accounting resources are available.
- Start small by offering discounts on few suppliers or buyers.
- Use dynamic discounting for maximum flexibility and automated tracking.
- Offer tiered discounts based on how early payment is made.
Early payment discounts can unlock value for both buyers and suppliers. However, the pros and cons need careful evaluation. Utilizing solutions like dynamic discounting and automating the discounting process can maximize the benefits and minimize the downsides for businesses seeking to leverage early payment discounts.