What Is an Early Payment Discount? A Small Business Guide

Hi, this is Tim Yoder with FitSmallBusiness. I've been a CPA for 25 years. Today, I'm going to teach you about early payment discounts. So, to find your early payment discount, you need to look at your invoice and find the payment terms. So, on this example invoice, we have terms here of 2% 10 net 30. So, what this means is that you get a 2% early payment discount if you pay within 10 days. Otherwise, the entire invoice is due within 30 days. Some invoices will have the early payment discount subtracted from the total of the invoice at the bottom.

This particular example does not. Sometimes they don't. Um so, we're going to need to calculate the early payment discount ourselves. How do we do that? We simply take the 2% * the $1,000, subtract that discount then to get the balance due on the invoice. So, what are some common invoice terms? So, the first would be 1 10 net 30. So, again, it's always the same format. So, this is a 1% discount if you pay within 10 days. Otherwise, the entire balance is due within 30 days.

So, other common terms we have 1% discount within 15 days, 2% discount within 15 days, 2% discount within 10 days, and so forth, right? So, you could make the early payment discount um whatever you would like. So, we'll talk a little bit about how you might decide um what type of invoice to offer your customers. So, why would you want to do this? What is the benefit to you as a vendor to providing early payment discounts to your customers? The main thing is cash flow, right?

Cash flow now is much better than cash flow a month from now. You would like to encourage your customers to pay as quickly as possible. And then the question becomes how much of a discount are you willing to give them in order to get them to pay quicker. So, you need cash now, right? You need cash to make your payroll, you need cash for your day-to-day business expenses. You hate to have to borrow cash on a line of credit when you have all of this capital sitting in your accounts receivable, right?

You would like those customers to give you that cash so you don't have to go out and pay to borrow it. By offering a early payment discount, you can reduce the risk of nonpayment. As the longer an invoice sits around, the more likely it's going to not be paid. The customer will forget about the service that was provided. It will get buried on their desk, something like this. By offering them an early payment discount, they might write a check immediately the payment the bill gets paid immediately.

Now, I'm not saying if something gets buried on somebody's desk, they'll never pay it, but it might require you to give them a phone call to remind them to pay it. And that's not free, right? You have to pay somebody or your bookkeeper or yourself, somebody has to call them and and that's not a fun task. Debt collection is one of the most uh undesirable bookkeeping tasks. So, you can avoid a lot of that debt collection by offering a prompt payment discount.

Uh the other benefit is just an increase in working capital in in general, right? The quicker you can turn over your receivables, meaning you issue an invoice, you get paid for the invoice, the more working capital you're going to have. Now, one benefit of that working capital is that if you have working capital, you can actually take advantage of early payment discounts from your vendors. Right? So, not only might you be offering early payment discounts to your customers, you might be able to take advantage of early payment discounts from your vendors.

So, if your vendors are offering you these discounts and you're not able to take advantage of them, you might consider offering your customers uh invoice discounts so that they pay you quicker. You can then take advantage of your early payment discounts. Okay, so what are some of the benefits to your customers? Obviously, they save money, right? 1% of an invoice may not seem like a lot initially, but if they have a lot of invoices, that could certainly add up very quickly.

Um it can build their business credit. So, just by paying paying your bills on time, taking advantage of early payment discounts, you can build up your credit. Um and also this can certainly build your relationship with the vendor. Uh vendors love to be paid early, right? Again, they like that working capital so they you have cash for payroll, they have cash for taking advantage of their own uh uh early payment discount. So, build a great relationship with your vendor.

So, the question then becomes So, if I'm going to offer an early payment discount, how much do I want to offer? Generally, you want to follow your industry standards. So, I have a couple years of experience um as a bookkeeper in a in a roofing company. So, I've also done various other things. Uh been a CPA for 25 years. So, I've been in a lot of different areas of accounting, but I did spend a couple of really valuable years as a bookkeeper at a roofing company.

Um and in the construction industry, early payment discounts are very common. Uh so, we had a we had a vendor that was our major roofing supplier and uh we know, we had I think it was a 1% uh 1% 10 um discount. So, we had 10 days to pay it with a 1% discount. Would have been fantastic. Unfortunately, our customers never paid us fast enough in order for us to take advantage of those. And so, perhaps if we'd been a little bit more aggressive at offering our customers early payment discounts, we could have got them to pay us quick enough that we could have uh then paid our suppliers and taken advantage of that.

So, look at your industry standards. Building industry, construction industry, it's very very common to give payment discounts. Um so, that's certainly one thing to look at. Try to stick somewhere near your industry standards, maybe a little bit better than your industry standards to give you a competitive advantage. So, speaking of competitive advantage, obviously you want to look at your closest competitors. All else being equal, if they're giving better discounts than you are, customers are going to go to them.

Now, maybe you can offer a better product or a better better service and you don't have to match their early payment discount, but it's something definitely to consider. Um considering your claim your your customer's payment history. Now, this can be a little bit tricky, right? Um you you I would never recommend giving different customers different uh early payment discounts without justification. Right? So, you might have a you might look at different areas of your business, perhaps certain like a certain line of your business, like going back to being a roofing company, uh perhaps your service department, maybe they have a lot of trouble collecting their payables their receivables on time.

So, maybe on service invoice invoices, you could offer a early payment discount, whereas on new roofs, new construction, or maybe replacing an entire roof, you don't offer your early payment discount there because those customers tend to pay on time or they attend to pay when they can, which is when they get reimbursed by their insurance company. So, you need to look at the situation. Don't just blindly offer the 1% or whatever discount. Don't blindly offer the discount to all of your customers.

Look and see which customers is it going to make a difference. If the customer in that particular line of business, if they already pay on time, then you don't want to waste the 1% if it's not going to do any good. If it's a line of business where they tend to be a little bit later, but they could pay on time, you think potentially, then perhaps offer the 1%. I would avoid just offering discounts haphazardly some to some customers and not other customers without some sort of written policy that outlines how you decide if if uh discounts are offered uh just to avoid any possible, you know, unfair discrimination type of of claims, right?

Have it written as to how you decide which customers are offered the discount. Or perhaps, like I talked about, the discount might best be offered, you know, you might vary the discount based on different lines of your business where customers tend to pay differently. So, if you're processing your invoices manually, it can be a lot of work to try to include all of these early payment discounts. So, I really recommend you use uh a good uh bookkeeping software or invoice processing software.

Uh QuickBooks Online is a great one, most popular accounting software out there. Um again, so we can see that their payment terms show up on the invoice, and this can be done automatically. So, let me show you just quickly how to set this up in QuickBooks Online. Uh if you go up to your cogwheel your options cogwheel in the upper right-hand corner uh of the screen and click on that, you'll get these different account and settings. So, if you go to the sell settings, sells form content, and then down here you need to turn on this discount option.

Once you turn on that discount option, you are going to have a terms field pop up anytime you create an invoice. When you create an invoice, you can set these terms to whatever you like. Also, you can set these terms customer by customer. So, when you set up a new customer, you could give them particular payment terms. Um and then whenever you do an invoice, that would be the default that shows up in this box. Of course, you could also change it then if you want for that particular invoice.

So, QuickBooks does allow very easily to be able to assign different payment terms to different customers. Again, I would make sure you have some sort of written policy uh that helps you determine which customers get which terms. So, that's how early payment discounts work. Hopefully, this will be helpful in allowing you to decide whether you want to to offer early payment discounts to your customers. Again, my name was Tim Yoder and I hope this was helpful. Thank you.

This transcript was generated automatically from the video's captions and may contain errors.