Many businesses invoice their customers, allowing them to pay for goods and services in 30-90 days. Because many small businesses need cash sooner rather than later, early payment discounts of up to 2% can be provided as an incentive. In this article, we will discuss what vendors and customers need to know about early payment discounts.
How Early Payment Discounts Work
An early payment discount (also called prompt payment discount or cash discounts) reduces the amount of money that the buyer owes the seller if the buyer pays before the due date noted on the invoice.
Early Payment Discount Example
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. Below you will see a screenshot of how payment terms are generally shown on an invoice:
How Much of a Discount A Seller Should Offer
The discount a vendor offers will vary based on a number of factors:
- What’s standard in the industry?
- Are the seller’s competitors offering early payment discounts? If so, how much?
- Has the client paid on time in the past?
The most common terms that vendors extend to their customers are:
1%/10 – Net 30
This means the customer can deduct a 1% discount if they pay within 10 days. If the customer does not pay within 10 days, then the invoice is due in 30 days with no discount. Use this payment term to incentivize those customers who never seem to pay their invoices on time.
1%/15 – Net 30
This means the customer can receive a 1% discount if they pay within 15 days. If the invoice is not paid within 15 days, then it is due in 30 days.
2%/10 – Net 30
This means the customer can receive a 2% discount if they pay within 10 days. If the invoice is not paid within 10 days, it is due in 30 days with no discount. It’s beneficial to offer a 2% discount for jobs that required a large outlay of cash that you need to recoup quickly.
2%/15 – Net 30
This means the customer can receive a 2% discount if they pay within 15 days. If the invoice is not paid within 15 days then it is due in 30 days with no discount.
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 (e.g. 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 discount. On the other hand, if your customer habitually pays late, this may incentivize them to pay early for a change.
Early 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. In the how to set up invoices tutorial, we show you how to set up early payment discount terms. To get up and running on QuickBooks, check out our free QuickBooks Course.
Benefits of Early Payment Discounts
Early payment discounts have benefits beyond the obvious one of saving the customer money:
Benefits for Vendors
There are several reasons why a vendor would offer early payment discounts:
- Get paid sooner.
- Reduce the risk of nonpayment or late payment by the buyer by getting paid sooner. 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.
Benefits for Customers
Here’s how a customer can benefit from early payment discounts.
- 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.
Invoice Factoring & Early Payment Discounts
If you’re a vendor who uses invoice factoring to get working capital, then you can potentially save money by offering early payment discounts.
Invoice factoring allows you to convert unpaid invoices into cash. If you want to learn more, check out our Invoice Factoring Guide where we compare and contrast the top 3 invoice factoring providers.
Factoring companies require that you finance at least $30K in invoices through them each month. If you don’t have that kind of invoice revenue or want more flexibility, accounts receivable financing may be a good alternative. To learn more, check out our best accounts receivable financing guide.
In most cases, the amount of money you can save in factoring fees will be significantly higher than what you will lose by offering the early payment discount.
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 problems. Usually, the customer and the vendor have different views as to when the clock starts ticking for receiving payment. The customer will want the clock to start 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.
Bottom Line: Early Payment Discounts
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. Still need an accounting software solution? Click here to see why we recommend using Quickbooks.