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. A common discount is 2/10 – net 30, which means buyers can earn a 2% discount by paying in 10 days. A $500 invoice would be discounted to $490.
Managing early payment discounts is a breeze with QuickBooks. You can create custom invoices, add early payment discounts, and send automated reminders to let customers know payment is due. Get started with up to 50% off QuickBooks Online.
Example of How an Early Payment Discount Works
Say you are a buyer and receive a $1,000 Net 30 invoice. If you pay the invoice within 10 days of receiving it, you may be able to deduct 2%, or $20, from the payment. On the invoice, these terms would be noted as 2/10 – net 30. In other words, if you pay in 10 days or less, the invoice can be settled for $980 instead of $1,000. If you pay after 10 days, you must pay the full $1,000.
The screenshot below shows how payment terms are generally shown on an invoice:
Sample invoice created in QuickBooks with early payment discount terms
How Much of a Cash Discount a Seller Should Offer
There are a number of factors to consider when determining how much of a cash discount you should offer for early payment. Be sure to research what the standard discounts are in your industry. Find out what your competitors are offering, if anything, and take into consideration your customer’s payment history. Some common early payment discounts include 1/10 – net 30, 1/15 – net 30, and 2/10 – net 30.
The discount a vendor offers will vary based on a number of factors:
- What is standard in the industry: 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 are not too far off from the industry standard.
- What early payment discounts are offered by the competition: Check out what kind of payment terms your competitors are offering. To stay competitive, you should offer similar payment terms.
- What your client’s payment history is: If a customer consistently pays on time, there is no need to offer early payment discount terms. However, you could decide to reward customers that pay on time with a customer appreciation discount periodically.
If it’s industry standard to offer discounts or your competitors are offering them, then you may be doing yourself a disservice by not offering a discount. You should match your discount to your industry standard or your competitors’ terms unless you offer some other advantage to customers, such as faster shipping or lower base prices.
Your client’s payment history will also come into play. If you have a customer who already pays early, there may be no reason to offer them a cash discount. On the other hand, if your customer habitually pays late, this may incentivize them to pay early for a change.
The most common prompt payment discount terms are 1/10 – net 30, 1/15 – net 30, 2/10 – net 30, and 2/15 – net 30.
1/10 – Net 30
This means the customer receives a 1% invoice discount if the payment is submitted within 10 days. If the customer does not pay within 10 days, then the invoice is due in 30 days with no discount. This type of prompt payment discount can be used to incentivize those customers who never seem to pay their invoices on time.
The 1/10 – net 30 early payment discount formula is:
Early Payment Discount = Invoice Amount x (1 – Discount %)
To put this into context, let’s say an invoice of $5,000 is paid within 10 days. In this case, the customer would pay $4,950, calculated as $5,000 x (1 – 0.01).
1/15 – Net 30
This means the customer receives a 1% cash discount if payment is submitted within 15 days. If the customer does not pay within 15 days, then the invoice is due in 30 days with no discount. This type of early payment discount can be used to reward those customers who have consistently paid on time under the 1/10 – net 30 prompt payment terms.
The 1/15 – net 30 early payment discount formula is:
Early Payment Discount = Invoice Amount x (1 – Discount %)
To put this into context, let’s say an invoice of $10,000 is paid within 15 days. In this case, the customer would pay $9,900, calculated as $10,000 x (1 – 0.01).
2/10 – Net 30
This means the customer receives a 2% cash discount if payment is submitted within 10 days. If the invoice is not paid within 10 days, it is due in 30 days with no discount. This type of prompt payment discount can be beneficial for jobs that require a large outlay of cash that you need to recoup quickly.
The 2/10 – net 30 early payment discount formula is:
Early Payment Discount = Invoice Amount x (1 – Discount %)
To put this into context, let’s say an invoice of $20,000 is paid within 10 days. In this case, the customer would pay $19,600, calculated as $20,000 x (1 – 0.02).
2/15 – Net 30
This means the customer receives a 2% cash discount if the invoice is paid within 15 days. If the invoice is not paid within 15 days, then it is 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 up front.
The 2/15 – net 30 early payment discount formula is:
Early Payment Discount = Invoice Amount x (1 – Discount %)
To put this into context, let’s say an invoice of $40,000 is paid within 15 days. In this case, the customer would pay $39,200, calculated as $40,000 x (1 – 0.02).
Prompt Payment Discounts in QuickBooks
QuickBooks makes it easy to create invoices that include early payment discounts. You can save different payment terms for each customer, so they’ll auto-populate when you draft an invoice. By creating payment terms for each customer, QuickBooks can alert you when a customer’s invoice is coming due. With this information, you can send customers a friendly payment reminder which can incentivize them to make the payment prior to the due date.
In the how to set up invoices tutorial, we show you how to set up early payment discount terms in QuickBooks. To get up and running on QuickBooks, check out our free QuickBooks Course.
QuickBooks makes it easy to create invoices that include early payment discounts. You can save different payment terms for each customer, and it will calculate the due date automatically when you draft an invoice. Get started with up to 50% off QuickBooks Online.
Prompt Payment Discounts in FreshBooks
Like QuickBooks, you can create early payment discounts in FreshBooks. You can customize payment terms and apply them to all customers or select specific customers. When you create an invoice for a customer, the payment terms will automatically populate based on the initial setup. However, you can change the payment terms for specific invoices if they differ from the standard payment terms for a customer.
If you assign prompt payment discounts to customers, FreshBooks will alert you when the due date for a customer’s invoice is coming due. When you receive this alert, you should send a friendly payment reminder to your customer. This will put the invoice on their radar and help you to get paid faster.
If you’re looking for a simple invoicing software that will help you to streamline the invoice and collection process, we recommend FreshBooks. FreshBooks allows you to create custom invoices, accept online payments, and send automatic payment reminders so that you can get paid faster. Sign up for a 30-day trial to see if FreshBooks is right for you. FreshBooks is also offering 60% off for 6 months on all subscription packages through 4/30/2021.
Benefits of Prompt Payment Discounts
Early payment discounts have benefits for both vendors and customers beyond the obvious one of saving the customer money. As a vendor, you will get paid sooner and can reduce the risk of nonpayment, which could result in hiring a collection agency. From the customer’s perspective, you will be able to build a good credit history with your vendor suppliers, which could result in an increase in your credit limit.
Benefits of Prompt Payment Discounts for Vendors
The benefits of early payment discounts for vendors are:
- Get paid sooner: You will get paid a lot sooner if you offer early payment discounts to customers, which means that you will have access to cash that you can use to meet payroll and take care of other day-to-day business expenses.
- Reduce the risk of nonpayment or late payment: By offering customers an incentive to pay sooner, you will most likely not have to worry about chasing down customer payments. The longer you wait to get paid, the more things that can happen that may prevent the buyer from satisfying its obligation.
- Increase working capital and reduce gaps in cash flow: By shortening the lag time between invoicing customers and receiving payment, your working capital will increase, and you will be able to maintain positive cash flow.
Benefits of Prompt Payment Discounts for Customers
The benefits of early payment discounts for customers are:
- Save money: The discounts add up over time to save you a significant amount of money, particularly if several of your suppliers offer the discounts.
- Build business credit: By paying your bills early, you can increase your business credit score. Vendors can leave notes on your business credit report, visible to other lenders and vendors, which say whether you pay your bills early, on time, or late.
- Build relationships with vendors: The sooner you pay a vendor what you owe, the more likely that vendor will be to work with you in the future.
Potential Problems With Early Payment Discounts
The terms of an early payment discount should be in writing to prevent any problems. Having the terms in writing prevents timing-related issues. Usually, the customer and the vendor have different views as to when the clock starts ticking for receiving payment. The customer will start the clock when their accounts payable department receives the invoice while the vendor will start counting on the date of the invoice. Clearing up this issue ahead of time will avoid problems later on.
In addition, having the agreement in writing helps prevent the customer from taking a discount they haven’t earned. For instance, in the $1,000 invoice example that we started the article with, the customer may pay after the invoice due date but still only pay $980 even though they didn’t earn the discount. Unfortunately, this is more common than you might think, and having a written agreement helps avoid it.
Invoice Factoring & Early Payment Discounts
Invoice factoring allows you to convert unpaid invoices into cash. In most cases, the amount of money you can save in factoring fees will be significantly higher than what you will lose by offering early payment discounts. Invoice factoring rates range between 0.5% to 5% of the number of invoices factored. In addition, origination fees and minimum factoring fees may be tacked on.
Factoring companies require you to finance at least $30,000 in invoices on a monthly basis. If you don’t have that kind of invoice revenue or you want more flexibility, accounts receivable financing may be a good alternative.
Frequently Asked Questions (FAQs) About Early Payment Discounts
We have included the most frequently asked questions about early payment discounts.
What is an early payment discount?
An early payment discount is when a vendor offers a discount to a customer if an invoice is paid before the due date. For example, an early payment discount of 2/10 – net 30 means that the buyer can deduct 2% from the total invoice amount if paid within 10 days of the invoice date.
How is an early payment discount calculated?
The early payment discount is calculated by taking the discount percentage ― such as 1% ― and multiplying it by the invoice amount. For example, a 1% discount on a $1,000 invoice equals $10. If the invoice is paid within the discount terms ― such as 10 days ― the customer would pay $990 ― $1,000 less $10.
How do I record an early payment discount in QuickBooks?
To record early payment discounts in QuickBooks, you need to complete three simple steps: First, create an early payment discount payment terms. Next, use the early payment discount terms on a customer invoice. Third, accept payment against an invoice with early discount payment terms.
Bottom Line
Early payment discounts are usually a win-win for vendors and their customers. Next time you issue or receive an invoice, consider proposing or requesting an early payment discount. The result will be a stronger vendor-customer relationship. If you still need an accounting software solution, then check out our best accounting software guide to see why we recommend using QuickBooks.
QuickBooks makes it easy to create invoices that include early payment discounts. You can save different payment terms for each customer, so they’ll auto-populate when you draft an invoice. In the how to set up invoices tutorial, we show you how to set up early payment discount terms.
