Who doesn’t love a discount? Many small business owners have realized that offering a purchase discount to their customers frequently leads to earlier payments and improved cash flow. Learn more about cash discounts and why they might be a good idea for your business.
Overview: What is a cash discount?
One of the best ways to get your customers to pay their bills early is to offer them a cash discount. A cash discount is usually around 1 or 2% of the invoice total, although some businesses may offer up to a 5% discount.
But before you jump on board, be sure to review the following accounting terms so you know exactly what you’re getting into.
Credit terms: A credit term is an agreement you offer your customer in exchange for selling merchandise or services to them on credit. Credit terms specify the amount of time that your customer has to make a payment. Not all of your customers will have credit terms, but the ones that do should have the terms entered into their accounts when setting up your accounting software. If you’re handling your accounting manually, you’ll need to manage terms and discounts for each customer individually.
Discount period: If you decide to offer a cash discount, the discount period is the time frame that the customer has to pay their invoice and take advantage of the discount. For example, if you give your customer terms of 2/10 net 30, they can take a 2% discount if they pay the invoice within 10 days of the invoice date. If they choose not to take advantage of the discount, they’ll need to pay the entire amount of the invoice within 30 days. Any payment received after 30 days would be considered late.
Discount percentage: As the business owner, it’s entirely up to you how much of a discount to offer. Although not every customer will take advantage of your offer, always assume that your customers will take the discount when deciding just how much you can afford.
Invoice due date: While many customers appreciate the offer of a small discount, the most important date on your invoice is the invoice due date, which is when payment is due.
Discounts can be especially helpful for newer businesses. If you’re still in the process of establishing relationships with customers, offering a discount provides your customers with a strong incentive to pay their invoices early while also helping to increase your cash flow if they do, making both parties happy.
An example of the cash discount
Nancy recently opened a cleaning service. The majority of her clients pay her in advance of her services, but she has extended credit to a few of her regular customers.
To provide an incentive for her customers to pay her earlier, Nancy starts to offer them a 5% discount if they pay within 10 days of the invoice date. Below is a copy of the invoice Nancy sent to one customer.
The cash discount formula is based on the terms included on the customer’s invoice. In this example, if Northside Insurance pays its $600 bill by July 10, it can take a 5% discount from the invoice total, and pay only $570. If it chooses not to pay early, the entire $600 is due by July 30.