This article is part of a larger series on Bookkeeping.
An early payment discount―also called a prompt payment or cash discount―is a reduction in an invoice balance when it’s paid before the due date. Early payment discounts encourage customers to pay early rather than waiting for the due date. For small businesses, getting customers to pay as early as possible is a good practice in accounts receivable management. When used strategically, it makes bookkeeping smoother and faster since there’s no need to follow up with customers to pay their balances. Our guide will discuss the calculation of early payment discounts, the benefits of giving these discounts, and other tips to make this an effective tool in collecting customer payments.
How to Calculate Early Payment Discounts
The formula to calculate the discount and the net invoice amount are:
Discount = Invoice Amount x Discount Rate
Net Invoice Amount = Invoice Amount – Discount
So, assume you invoice a customer for $850 with a discount term of 2/10 Net 30:
- Step 1: Calculate the early payment discount as 2% of $850, or $17
- Step 2: Deduct the discount of $17 to get the balance due of $833
This means that the customer can pay $833 instead of $850 if they settle the bill within 10 days of the invoice date instead of waiting for the due date to pay.
Common Payment Terms
It’s important to understand common payment terms when calculating early payment discounts and applying them to your invoices.
- 1/10 Net 30: The customer receives a 1% prompt payment discount if the payment is received within 10 days of the invoice date. If the customer doesn’t pay within 10 days, the full invoice amount is due in 30 days with no discount. This prompt payment discount might be good to incentivize those customers who never seem to pay their invoices on time.
- 1/15 Net 30: This means the customer receives a 1% discount if payment is received within 15 days. If the customer doesn’t pay within 15 days, the full invoice amount is due in 30 days with no discount. This early payment discount can be used to incentivize customers who consistently pay on the due date to pay their invoices 15 days sooner.
- 2/10 Net 30: The customer receives a 2% early payment discount if payment is received within 10 days. If the invoice isn’t paid within 10 days, it’s due in 30 days with no discount. This type of prompt payment discount can be used to accelerate cash flow with a larger discount for jobs that require a large outlay of cash that you need to recoup quickly.
- 2/15 Net 30: This is when the customer receives a 2% discount if the invoice is paid within 15 days. If the invoice isn’t paid within 15 days, then it’s due in 30 days with no discount. Similar to the 2/10 Net 30 early payment discounts, this type of early payment discount is ideal for jobs that require you to spend a large amount of cash upfront.
Benefits of Prompt Payment Discounts
Early payment discounts have benefits for both sellers and customers beyond the obvious one of saving the customer money.
Should You Offer Early Payment Discounts?
When deciding whether implementing early payment discounts is a good strategy for your business, you should consider the following questions:
- Are your competitors doing it? Find out if offering early discount payments is an industry standard. If no one else is doing it, then evaluate if it gives you an edge over your competitors.
- Is getting paid sooner crucial to your business? Prompt payment discounts can have a significant impact on your profitability. It’s important to weigh the benefits of getting paid early and increasing your cash flow against the reduction in profit you’ll experience from offering the discount.
How Much Early Payment Discount to Offer, If Any
The discount a seller offers will vary based on several factors.
- The industry standard: Find out what kind of payment terms other businesses in your industry are offering. You want to make sure that the payment terms you offer aren’t too far off from the industry standard. On average, the typical discount rate is 1% to 2% per invoice. The rate best for your business depends on how if your customers expect a large discount and how desperately you need cash quickly.
- The prompt payment discount the competition offers: Check out what kind of payment terms your closest competitors are offering. To stay competitive, you should offer similar payment terms.
- Your client’s payment history: If a customer consistently pays on time, there’s no need to offer early payment discount terms. However, be careful when rewarding late-paying clients by offering them discounts. Your customers that always pay on time might not be happy about the policy.
There’s no rule that you must offer every customer the same payment terms. If you offer different terms, however, be sure to follow a written policy to justify the terms offered to defend against potential accusations of favoritism or discrimination.
Tip: Implementing early discount payments can be tedious if you’re relying on manual bookkeeping. Accounting software like QuickBooks Online allows you to set up specific terms for each customer. Simply set up the discount terms when creating an invoice or sales receipt, and the program will automatically calculate and apply early payment discounts to your invoice.
How To Avoid Potential Problems With Early Payment Discounts
The terms of an early payment discount should be clearly stated on all invoices. Generally, payments must be received by the seller within the stated number of days from the invoice date for the discount to be applied.
However, some clients will try to take the discount as long as their check is written within the discount period. You should establish a firm rule regarding this issue and display it at the bottom of all invoices that include an early payment discount.
How Early Payment Discounts Work with QuickBooks Online
Suppose Paul’s Plumbing invoices a customer for the installation of a new bathroom and sink faucet for $1,000. The term for the early payment discount is 2%/10 Net 30, so if you receive payment in 10 days or less, the invoice will be reduced to $980. If the customer pays after 10 days, they must pay the full $1,000. The screenshot below shows how this payment term is displayed on an invoice from QuickBooks Online.
How To Set an Early Payment Discount in QuickBooks Online
If you’re a QuickBooks Online user, you can add a discount to an invoice or sales receipt for customers who pay early by turning the Discount feature on. To do this, click on the gear icon on the top right part of your dashboard, select Account and Settings, and then choose Sales. From the Sales form content tab, toggle Discount to on.
Depending on your needs and goals, offering early payment discounts can help speed up the collection process—but it can also pose some challenges, especially when not implemented properly. It’s best to consult your accountant or bookkeeper to analyze the impact of early payment discounts on your business.
If you decide that early payment discounts are a win-win for you and your customers, you should leverage your accounting software to automatically apply discounts to your invoices. You can explore our best accounting software guide to see why we recommend using QuickBooks.