Early Settlement Discounts

NotesVideoQuizObjective Test

Offering early settlement discounts

There are four main reasons why a business may offer its customers discounts to pay early:

  1. If cash is received earlier, it will improve the supplier’s liquidity position, because it reduces the length of its cash operating cycle. 

    This will be particularly important if a seller is suffering from cashflow problems.

  2. If the cash from customers is received early, the cost of financing receivables is reduced. 

    For example, if the supplier has an overdraft agreement under which it borrows at a cost of 10% per annum, then provided that the cost of offering the discount is less than the cost of the overdraft, the supplier will be better off financially.

  3. When customers are deciding which payments to make to suppliers and which ones to delay, they are likely to pay those suppliers offering a discount for early payment first. 

    From the point of view of the supplier offering the discount, this means that the incidence of bad debts is likely to be reduced, since customers will choose to pay them first if they are short of cash.

  4. It is possible that offering a discount may provide an incentive to new customers, because the cost of the goods from a supplier offering a discount may now be less than those of a supplier not offering a discount, provided that the potentially new customer pays within the specified time limit.

NotesVideoQuizObjective Test