What Is an Early Payment Discount (EPD)?
An early payment discount is a reduction on the invoice’s total payable value, which vendors provide to get buyers to pay their outstanding bills early. For example, if a client owes your business Rs. 70000 to be payable in 30 days, and you offer an early payment discount of 3% for an early payment within 10 days, then the buyer/client gets to save Rs. 2100 and pay Rs. 67900 to get an outstanding bill of Rs. 70000 cleared.
Also known as prompt payment discounts, they come in handy when a seller/vendor needs to increase their cash flow and boost liquidity. Buyers save money, and sellers get money early on, just lower than what was owed. A prompt payment discount is a great sales and marketing move that improves business relationships, lets businesses access funds trapped in the supply chain, and improve day sales outstanding, working capital, & overall financial metrics.
- Early payment discounts are sales discounts businesses offer on the total invoice amount if buyers pay within the discount period.
- Early payment discount terms allow buyers to avail of cash discounts on their accounts payable and help sellers improve liquidity by acquiring the cash tied up in their accounts receivables.
- Such prompt payment discounts can be expensive if they cut a business’s profit margins.
- Early pay discounts are great for business growth for both buyers & suppliers. They secure the supply chain, improve the supplier’s financial position, boost cash flow & help manage working capital better, and reduce the risk of late or non-payments.
- There are three key types of early payment discounts: static discounts, dynamic discounts, and sliding scale discounts.
How Do Early Payment Discounts Work?
Static, dynamic or sliding discounts reduce the total amount payable on an invoice if the payer makes the payment within a particular date. A static discount offers a flat percentage off if sellers receive a payment within a set number of days. Dynamic discounting and sliding discounts offer variable payment discounts on accounts payable.
Early pay discounts are a type of trade finance wherein sellers forego a certain sum on their accounts receivable to get their hands on the money stuck in operations. The discount on unpaid invoices motivates buyers to avoid late payments, and sellers can access cash for any requirement or boost cash flow.
The following example can help elucidate:
Suppose a supplier has an outstanding invoice of Rs. 50000. The invoice date is September 15th, and the final due date is October 14th, 30 days later.
Then as per the payment terms of an early payment discount, the customer receives a discount rate of 4% if they pay within 10 days of the invoice date. If they avail of the early payment discount, the customer pays Rs. 48000 and saves Rs 2000 on the bill.
If the buyer does not pay within that date, they forfeit the payment terms and must pay the entire amount within the due date.
How to Write an Early Payment Discount on the Invoice?
An early payment cash discount is always mentioned on invoices through the payment terms. These terms offer some leeway to customer payments if paid early. Notations for mentioning an early payment discount on invoices can be:
- 4/10, Net 30
- 4/10- Net 30
- 4% 10, Net 30 days
In all the above cases, the customer receives early pay discounts of 4% on the total invoice if they pay within 10 days of the invoice date. Beyond that, they have 30 days to pay the entire amount on the invoice without any discount.
Types of Early Payment Discounts
An early payment discount is generally of three types, each with its features & applications. Businesses can use a combination of different types as they deem fit.
- Static: A static early payment discount rate offers a flat discount to buyers. The business determines the payment discount terms beforehand. These early payment discounts are the least flexible but can come in handy when the payee needs the cash urgently.
- Sliding scale: Sliding scale discount rates go on decreasing with time. So, the earlier the client pays, the more considerable the discount. These discount types allow a business to control the payment date and offer customers an extended time window for making payments at discounted rates. They are ideal for reducing day sales outstanding and late payments.
- Dynamic: This is yet another flexible early payment discount type that builds upon the sliding scale type & takes into account the supply and demand of the purchased commodity. The buyer proposes to vendors/suppliers to take an early payment at a specific discount rate on the invoice. The supplier may accept or present a counteroffer, the two parties agree, and transactions occur per the agreed-upon payment terms.
Benefits of Early Payment Discounts
Early payment discount benefits parties on both sides of the purchase equation. Buyers get to pay less & secure their supply chain through early payments. Vendors receive early payments that can help them shore up their finances, improve their cash pool, and acquire precious liquidity to boost working capital. Buyer-seller relationships become more robust when early pay discounts come into the picture.
Benefits for Vendors:
- Quicker payments:
The discounted payment may seem like it could be more economical for the vendor. Still, the quick payment helps businesses increase DSO and brings in funds without needing any credit line or working capital loan.
- Increased cash flow:
The early payment injects much-needed cash if a company’s suffering from starved cash flow. When payments come in from many customers, the incoming funds can be used for further operational expenses, clearing accounts payable, and expansion.
- Increased customer loyalty:
Offering an early payment discount is a great sales & marketing strategy. You let your buyers save money, and they help you maintain your financials. Improved customer loyalty and stronger business relationships are consequential results of early payment discounts.
- Potential savings:
Early payment discount is a manner of trade finance wherein businesses get to access the money caught up in the supply chain. These early pay discounts are a much more cost-effective way of acquiring funds than other financing avenues, such as working capital loans, invoice or credit factoring, and lines of credit. The potential savings are enormous.
Benefits for Customers
- Increased Options:
Offering a discount percentage by paying early is a great convenience for customers. With dynamic & sliding scale early payment discounts, clients get a chance to decide when and how much to pay.
- Rewards for “good” Behaviour:
An early payment discount coaxes buyers to clear their outstanding early and receive a cash discount for early payment. Such prompt payment is aptly rewarded and thus promotes customer loyalty & stronger business relationships.
- Building Business Credit:
Early payments boost the credibility of a business and may lead to long-term business relationships with vendors. Vendors may offer customers better deals, discounts, and attractive early payment discount terms.
How to Calculate an Early Payment Discount?
The formula for calculating early payment discounts is overtly simple.
If the terms on the invoice state 4/10- Net 30, then the EPD on the payment for goods sold or services provided is 4 per cent on the total invoice if paid sooner within 10 days.
Let the total amount payable is Rs. 100000, then the sales discount amount is:
(4/100) *100000 = Rs. 4000, and the buyer can clear all outstanding by paying Rs. 96000 within 10 days. Otherwise, they need to pay the total amount within 30 days.
The formula can be written as: Discounted invoice amount = Original/total invoice amount (1 – EPD%) or (Original invoice amount – EPD% Original invoice amount).
Examples of Early Payment Discounts
Numerous businesses across different sectors offer early payment discounts.
For example, if you are a raw material supplier to the LED assemblers and supply different goods such as semiconductor wafers, LED chips, glue & colour, PCBs, etc. Say you are offering customers a 60-day payment period but suddenly require some urgent liquidity.
Now, say a medium enterprise was your buyer and bought goods worth a total of Rs. 200000. So, a probable early payment discount example can be:
- A static discount of 3/15 – net 60: 3 % discount on Rs. 200000, with the buyer having to pay Rs. 140000 if they make the early payment within 15 days.
- A series of discounts of 3/15, 2/30,1.5/45 – net 60: Early payment discount amount decreases as the due date gets near. The method of calculation remains the same.
- A dynamic discount proposed by either you or the buyer: Both parties decide upon a prompt payment discount rate that’s beneficial to either.
How much should your discount be?
Deciding the amount of early payment discount is a critical factor. Choose too high an amount, which may adversely affect your operating margins & working capital.
An excellent way to determine the EPD amount is by calculating the profit margin of the goods sold. Then determine the profit margin you want after applying different early payment discount rates.
[Tip: Here’s the formula for calculating the profit margin of a particular good: ((Price of product – Total cost of products sold)/ Product Price) *100]
Be aware of industry standards and what EPD rates your competitors offer for similar goods & services as well.
When to Offer Early Payment Discounts?
If a business has an urgent need for some funding and liquidity, early payment discounts can help them tap into the money stuck in the account receivable. EPDs may bring in money early when necessary.
An early payment discount encourages buyers or debtors to pay early in exchange for a discount.
Offering an early payment discount is a handy way to incentivise early payments. Flat price cuts, sliding & dynamic discounts bring down the outstanding amount and encourage them to pay earlier.
Net and gross are two different manners of recording an early payment discount. The net method records the EPDs yet to be availed, helping businesses determine where to apply them. The gross method looks into the discounts that have already been taken.