The key difference between trade discount and cash discount is that trade discount refers to the reduction in list price known as discount, allowed by a supplier to the consumer while selling the product generally in bulk quantities to concerned consumer, whereas, cash discount is discount given by the supplier on its cash payments to recover the cash debts on time as it motivates the buyer to pay cash early as they are given discount if they pay within the stipulated time.
Discounts are an integral part of business trade. Since time immemorial, it has been part of the transactions that buyers offer, and sellers receive either implicitly or explicitly. Two such vital types of discounts are:
Trade discount is provided by the seller at the time of purchase to attract customers and increase sales. More importantly, the sellers are interested in those customers who are interested in buying bulk quantities. Since it is offered at the time of purchase, it is often implicitly part of the prices of the products and is included in the transaction before the billing statement is printed.
Cash discount, on the other hand, is offered at the time when the seller offers payments and is calculated as an additional deduction on the printed invoice. It is offered subject to certain conditions which incentivize the buyer to make a large part of the payment upfront and pay remaining installments as soon as possible.
Example of Trade and Cash Discount
Consider a tractor maker XYZ and an ABC firm who buys the tractor from them with a price of each tractor being 5,00,000. Assuming ABC buys 50 tractors in total as a part of an annual contract and XYZ offers a trade discount of 10% to ABC. Then
List price = 5,00,000 * 50 =$2,50,00,000
Trade discount = 10% = 10% * 2,50,00,000 = $25,00,000
The amount payable as per invoice = List price – discount
= 2,50,00,000 – 25,00,000
ABC was liable to pay this payment in 90 days. Let’s assume that XYZ, in an effort to get payment early offers an additional discount of 3% to ABC if it makes these payment in 30 days. In that case the calculations will be:
Amount payable as per invoice = $2,25,00,000
Cash discount = 3% = 3% * 2,25,00,000 = $6,75,000
Amount payable (within 30 days) = 2,25,00,000 – 6,75,000
Please note that the calculation of trade discount happens before printing of the invoice while the seller offers a cash discount on the final payment.
Critical Differences Between Trade and Cash Discount
Trade discounts are typically offered as a part of a discount policy to the seller. Hence most of the time, this discount is already inculcated in the listed prices of the products. It is in contrast to the cash discount, which is offered over and above the listed price.
Trade discount though part of the catalog itself may vary a bit based on the quantity purchased by the buyer. It is because the main incentive of this discount is to make sure that the buyer goes for bulk quantity. It’s a win-win situation for both parties. For buyers, the unit price per quantity decreases, which increases the marginal utility in economic terms. For the seller, as more and more quantity is sold, his quantity sold per customer increases leading to better throughput and warehouse efficiency. Now he would have to spend less cost on storage and distribution.
Trade discount is a mechanism used by the seller to make sure that it retains the buyer not only for this transaction but also for future transactions making him a repeat buyer. It is mainly a part of a long term strategy wherein the buyer wants to decrease its distribution, marketing, sales, and other transactional costs. A cash discount, on the other hand, is more about getting payments as quickly as possible. Through this, the seller wants to make sure that he gets payments fast, upfront, and in full rather than in installments.
Since it is more quantity specific rather than focused on the transaction cost, it is mainly offered by the wholesalers to retailers. There is less credit risk as the focus is mainly on increased throughput and repeat business for both buyers and sellers. Retailers mainly offer a cash discount to consumers. The transaction size is less, and the credit risk is more.
Since trade discounts are already inculcated in the product prices displayed in the catalog, they are not recorded in books. A cash discount is not part of market prices and is offered over and above it. Hence, they are recorded in the books for both sellers and buyers.
Trade discount varies with the products and the quantity purchased by the seller. A cash discount is more specific with the timing of payments and installments. The aim is to get upfront payment instead of installments in the future. As a thumb rule – less the installments, more is the discount.
Trade discount is product specific and is not discriminated based on the payment mechanism. As cash discount is more focused on reducing credit risk and delay of future installments, it is offered only to customers who make payment at the time of taking delivery, preferably in cash.