Definition of Cash Discount
A cash discount, otherwise known as an early payment discount, is a price reduction given by a service provider or the seller of goods in a bid to encourage the customer to pay for purchased products within a period. The service provider or seller refers to a cash discount as a sales discount while the buyers refer to the same cash discount as a purchase discount. Cash discounts can reward and motivate buyers to buy more, and reduce inventory cost on the part of the seller.
How Cash Discount is Calculated?
The amount of cash discount offered by the seller is usually a percent of the total amount of goods bought, and sometimes, the cut is stated as a fixed amount. The cash discount is recorded on an invoice in this format:
[Percentage discount][If paid within xx days] ÷ Net [normal number of payment days]
Thus, if the seller offers a discount of 3% of the total amount on an invoice and is paid within 15 days or the number of payment days which is 30, the information would appear on the invoice as follows:
3% 15 / Net 30
The Pros and Cons of Using Cash Discount
Cash discount benefits the seller and buyer in some ways. The seller offers a cash discount to obtain an early use of cash in the event where the seller is short of cash. Also, to encourage the buyer to make an immediate payment upon the purchase of goods.
Occasionally, service providers give cash discount when their fee is paid immediately a service is rendered. For instance, my dentist gives a cash discount of 5% to patients that pay immediately the service is rendered. As far as my dentist is concerned, the cash discount saves his time, mailing statements, and cost of billing. More importantly, cash discount saves him from getting partial payments from the client thus he has fewer receivables and more cash.
Cash discount can improve the cash flow of business while reducing bad debts. At the same time, cash discount may cut the profit margin of the seller unnecessarily. In the world we live in today, buyers who buy goods on credit hardly pay up before the due date. Unfortunately, many sellers spend time and resources reaching out to clients to make payments. Cash discount can be helpful as it gives the buyer an incentive to make payment immediately and that means that the seller need not spend time or money on collection. The prompt payment by buyers makes it easier for the seller to settle his bills.
The Importance of Cash Discount for Small Businesses
Cash discount is beneficial to small businesses as it helps them to retain more profit and revenue. While small companies vet customers before extending great lines credits, there's a likelihood that the buyer not make payment or claim bankruptcy. When that happens, small businesses do not have any option than to write it off as bad debt. Even though giving a cash discount means the business receives 98 or 99 percent of the sales price, cash discount still provides more money for the small business.