The invoicing process is a crucial accounting task vital to your business’s operations and cash flow. Some businesses offer early payment discounts as a way to reward their customers for paying their bills before they are due. You might have heard of this strategy—and you might have taken advantage of it yourself as a customer—but you might still be confused about whether this is a good strategy for your business.
Early payment discounts can be a good way to speed up collections in your business and improve your cash flow. But they have to be used correctly, and they aren’t right for every business. If you aren’t careful, early payment discounts can cost you not only money but also relationships with your customers.
In this article, we’ll take a close look at early payment discounts, including how to determine if offering them is a good strategy for your business.
Typically, small business owners are advised against discounting their offerings on a regular basis. Doing so can negatively impact your bottom line and encourage undesirable customer purchasing behavior.
The exception to this rule can be early payment discounts on invoices. When you use early payment discounts as a strategy, several positive things can happen:
By now, you might be wondering why you wouldn’t offer early payment discounts. Although the advantages are compelling, there are some risks and downsides to offering discounts to your customers for paying early.
Business opportunities are usually accompanied by risk, and the same holds true for offering your customers early payment discounts. Some of those risks and downsides include:
Now that you know some of the early payment discount advantages and disadvantages, let’s look at the most common early payment discounts.
Early payment discounts are typically nominal—1% to 2% per invoice. On a large invoice, though, even a small percentage can lead to sizable savings for the customer. And collecting a large invoice in a fraction of the time can help you keep your business running smoothly.
Most companies that offer early payment discounts have standard payment terms of net 30. This means the entire amount of the invoice is due within 30 days of the invoice date. When a company offers an early payment discount, they reduce the amount the customer pays in exchange for the customer paying in less than 30 days. The most common early payment discounts are “2/10 net 30” and “2/15 net 30.”
If that looks like some strange sort of math, hang with us for a second. The first number in the early payment discount—the two—is the percentage amount of the discount. So, the customer would get a 2% discount on the invoice.
But the customer must give you something in return for this discount. That’s where the second number comes in.
The number behind the forward slash is the time period within which the invoice must be paid in order to get the discount. Payment discount terms of 2/10 indicates a 2% discount if the invoice is paid within 10 days, and 2/15 indicates a 2% discount if the invoice is paid within 15 days.
The “net 30” indicates the normal payment terms of the invoice. If the customer chooses not to take advantage of the early payment discount—or if they pay after the discount timeframe—the entire amount of the invoice is due within 30 days.
To put this in plain English, in exchange for a 2% discount, the customer is giving you the money owed to you 15 to 20 days sooner than is typically required. If the customer chooses not to take advantage of the discount, the full amount of the invoice is due 30 days from the date of the invoice.
Some businesses offer variations on the 2/10 net 30 and 2/15 net 30 early payment discounts. You might see 1/10 net 30 or even 2/10 net 60. There’s no “wrong” way to offer an early payment discount, but remember the goal here is to encourage your customer to pay you earlier than you would normally expect to be paid.
We’ve looked at the benefits and risks of offering early payment discounts as well as the most common types of early payment discounts. You might still be wondering if early payment discounts are a good strategy for your business. Take some time to consider the following four questions to determine if you should offer early payment discounts to your customers:
Offering early payment discounts on your invoices can be a good way to speed up the collections cycle in your business, improve your cash flow while increasing customer goodwill, and, of course, avoid late payments. It can also lead to some challenges, including a loss of profitability and administrative burdens.
Before deciding whether or not to offer early payment discounts to your customers, work with your accountant or bookkeeper to analyze the impacts—both positive and negative—these discounts could have on your business. Your accountant or bookkeeper can also help you set up your accounting software to streamline the administration of early payment discounts should you decide to offer this benefit to your customers.
Billie Anne Grigg is a contributing writer for Fundera.
Billie Anne has been a bookkeeper since before the turn of the century. She is a QuickBooks Online ProAdvisor, LivePlan Expert Advisor, FreshBooks Certified Beancounter, and a Mastery Level Certified Profit First Professional. She is also a guide for the Profit First Professionals organization.
Billie Anne started Pocket Protector Bookkeeping in 2012 to provide an excellent virtual bookkeeping and managerial accounting solution for small businesses that cannot yet justify employing a full-time, in-house bookkeeping staff.