How to account for a sales discount

Additionally, early payment discounts might not suit your business if you already have a reliable cash flow or access to alternative funding options with lower costs. Most businesses do not offer early payment discounts, so there is no need to create an allowance for sales discounts. If your business is experiencing cash flow problems, offering a cash discount to your customers can help increase incoming cash and allow you to pay your bills on time. In their calculation, your business offers a 2% discount for customers that pay an invoice in 10 days. Essentially, your business is gaining the use of money for 20 days in exchange for 2% off.

• The seller usually states the standard terms under which a sales discount may be taken in the header bar of its invoices.
• Used as an incentive to get your customers to open their wallets a little sooner, an early payment discount may be a good option for your small business.
• A small discount for early payment may be all it takes to build loyalty among your clients.
• On-demand solutions are transforming traditional early payment strategies to make working capital access more affordable and equitable for suppliers.
• Any customer that you sell to on credit should have credit terms assigned to them in your accounting software application, which serve as an informal agreement between you and them.
• However, early payment discount accounting requires you to add another account to record the money your business is “losing” for the sale discount.

Payment terms such as “5% 10 net 30” mean a client can receive a 5% discount if their invoice is paid within 10 days; otherwise, they must pay the full amount within 30 days. Example
ACME Services Company regularly extends credit to customers by issuing sales invoices net 30 days. In other words, the due date on each new invoice is 30 days in the future. But it offers a 5% early payment discount if customers pay within 10 days. Whenever cash flow is satisfactory, Brilliant saves 5% on its purchases from ACME by paying quickly. Early payment discounts are quite expensive, and so should only be offered to customers when the seller is having severe cash flow problems.

Should you offer early payment discounts?

Be sure to consider your company’s cash balances and cash needs before paying invoices prior to their due dates. A discount of 1% for paying 20 days early equates to an annual interest rate of approximately 18%. On-demand solutions are transforming traditional early payment strategies to make working early payment discount accounting capital access more affordable and equitable for suppliers. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee.

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• If an overdraft causes several of the buyer’s checks to be returned to its vendors, the total amount of overdraft fees will be even greater.
• Consequently, early payment discounts – especially for substantial amounts – should only be offered when a business is in dire financial straits and has no other sources of cash.
• Thus, the net effect of the allowance technique is to recognize the estimated amount of the discount at once and park that amount in an allowance account on the balance sheet.

J Co has a 30-day payment period and has offered the customer a 3% prompt payment discount if payment is made within 14 days. Based on past experience, the customer is expected to pay within 14 days and therefore will be entitled to the 3% discount. Add a second line to the payment form, posted to either the same expense account as the original purchase or a dedicated contra expense account for discounts (see Notes above). If more than one tax code was used on the purchase invoice, add separate lines for the discount amounts subject to each tax code.

What Is an Early Payment Discount?

You offer an early payment discount of 4% if the customer can pay within 15 days (4/15, Net 30). However, early payment discount accounting requires you to add another account to record the money your business is “losing” for the sale discount. When the customer pays, it’s time to reverse the entry by creating a second journal entry. Debit your Cash account to increase it and credit your Accounts Receivable account to decrease it.

If this occurs 18 times in a year, the net annual savings will be approximately $301 [$16.78 X 18 times; or $360 per year saved minus the annual interest paid to the bank of $59 ($980 X 6%)]. There are three types of early payment discounts — static discounts, sliding scale discounts and dynamic discounts. If you have little markup on your products and services, offering even a small discount can quickly cut into your operating margin, leaving you with little to nothing in profit. When initially setting pricing for products and/or services, make sure to take any future early payment discounts into consideration. On Donna’s Donuts’ next invoice, you decide to offer a 2% discount. The discount would be reflected as “2/10 net 30,” meaning that if she pays the bill within 10 days, she’s entitled to a 2% discount on the amount.

Increases customer loyalty

Find out the advantages and disadvantages of offering early payment discounts. When deciding your cash discount, consider your industry standards and competitors. Find out how much other businesses charge for similar services or products. You may choose to offer a low enough early payment discount to stay competitive. Customer retention is the holy grail of long-term business growth. Research has shown that increasing customer retention rates by 5% will increase profits by 25% to 95%.

One overdraft fee could be greater than the early payment discount. If an overdraft causes several of the buyer’s checks to be returned to its vendors, the total amount of overdraft fees will be even greater. Offering discounts cuts into your profits (though the benefits of early payment are often still worth it if your business has tight margins). If you opt for static discounts, customers may also take advantage of static discount terms attached to an invoice, deducting the discount without actually paying early. Improving cash flow without taking on debt is the main benefit of offering an early payment discount. By increasing your cash flow, you are better positioned to pay your bills on time, invest in growth opportunities and bridge cash gaps during key reporting periods like quarter-end.

Here’s how to decide whether to give discounts to your customers if they remit payment ahead of schedule. Traditionally, early payment discounts are initiated by the supplier, which will offer discounts to customers when invoicing for goods or services. However, this type of arrangement lacks both certainty and flexibility. If, based on past experience, J Co did not expect the customer to make the payment within 14 days, then the full $2,000 would have been recorded as revenue in the first instance. If the payment was made within the 14-day period after all, this would require an adjustment to reduce revenue by $60.

• EXAMPLE 2
  J Co sold goods to another customer with a list price of $8,000.
• Because invoices give customers time to pay their bills (e.g., days), many businesses offer an early payment discount to speed up payments.
• An early payment discount or cash discount is offered as a means to get your customers to pay their bills a bit earlier.
• Again, offering a discount for prompt payment can encourage customers to pay their bills early, boost cash flow, and strengthen relationships.
• Debit your Cash account to increase it and credit your Accounts Receivable account to decrease it.
• For suppliers, an early payment discount improves cash flow by speeding up customer payments, thereby reducing their days of outstanding sales.