EARLY DISCOUNT OR LAST MINUTE?

CONTROLLING CASH OUT

Payment Strategies:

EARLY DISCOUNT OR LAST MINUTE?

Robert Inkaka Kanyamanza

Many suppliers offer a discount for early payment. An invoice may state terms of 2 per cent/10, net 30, for example. This means the customer can take a 2 percent discount for payment within 10 days; otherwise the full payment must be paid with 30 days.

Should you pay early and take the discount or wait to pay in 30 days?
Here are some factors to consider:

  • If you pay in 10 days, does the discount cover any additional borrowing cost? Do you have room on your line of credit to cover it?
  • If you are using surplus funds to pay early, will the discount cover the lost interest you could earn?
  • Do you have more expensive debt to pay down that could save you more than the discount?

Example: Your business buys $ 10,000 worth of raw material each month. You are offered a 10 percent/10 discount. Your interest rate is 7 per cent, and your credit line makes it possible to borrow the money. You take the discount and pay $9,800 after 10 days. Your interest will be $ 9,800 x 0.07 x 20/365 = $37.59. Therefore, you pay $9,837.59

By taking the discount you have saved: $10,000 – $9,837.59 = $162,41

In another example, what if you had paid $9,800 out of surplus funds that could have earned 4 per cent in a 30-day short-term investment that you bought at the beginning of the month?
The amount of lost interest equals $9,800 x 0.04 x 30/365 = $32.21. It does not come close to the amount you save by paying early.

In this example you should obviously take the discount. However you should always consider that early payment has repercussions on cash flow, your credit line and “lost” opportunities. Discuss your particular situation with your accountant and if you intend to borrow to pay early – with your banker.

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