Many companies utilize an early payment discount when requested by suppliers. However, the tool has the potential to do far more for your company.
It can help to improve the status of the accounts receivable department. The discount tool is a popular and viable strategy that can help to get payments on time, lower the risk of bad debt, and improve your company’s cash flow. It also could help to generate a greater profit.
Why does the early payment discount work?
To properly utilize the tool, it is essential to understand what it does and how it works. Ultimately, it provides your customers with a good reason to pay their debts early. They get a discount and you get the money owed to you sooner than you might otherwise, helping to improve your company’s financial standing.
Many customers will love the idea of paying early if they can get a discount. This type of discount is a percentage of how much is due from the customer. The customers can reduce that percentage if they pay their bill within a certain timeframe that you determine. A business might offer a 2% discount for those customers who pay their invoices within the first 10 days of the billing period rather than waiting until a full 30 days have passed, for example.
Some companies might worry that they are essentially leaving that 2% (or another percentage) on the table and that it could eat into their profits. However, the opposite tends to hold true.
The customers, who want to take advantage of that discount, are more likely to pay early. This provides your company with cash quickly. It also reduces the risk of customers not paying.
Below, you will find three different strategies that you can use with this tool.
Strategy #1: Accelerate Payments Using Discounts
Having enough cash on hand is always the primary concern of businesses regardless of the industry. Of course, it is not always possible to know just when extra cash will be needed to handle various needs or expenses for the business.
In some cases, the company could need extra money for an entirely unforeseen expense. COVID-19 is a prime example of this type of unpredictable event. A year ago, no one could have predicted where the world would be right now. Other times, you might know that you need some extra cash. For example, some industries have lower amounts of cash flow depending on the season.
When companies experience the need for more cash, there are several things that they tend to do. Often, they will consider borrowing from the bank or another lender to help meet their needs. Other options might include factoring receivables or using business credit cards. These are the “standard” options that many companies have become accustomed to using during those times.
However, they may not always be the best options. When you are borrowing money from the bank or putting expenses on credit, you will have to incur interest. This means that you will end up owing more money. Eventually, this can start to take its toll if you are not careful.
Another option that you should consider is using the payment discount strategy to accelerate the payments you are getting from your customers. As discussed above, this is a simple method of improving your cash flow, and it can work quickly.
Offer a discount to a customer who pays within a shorter timeframe and you will find that many customers are willing to do this. After all, your company is not the only one that wants to save money. The discount is a fantastic way to persuade customers to pay early.
Keep in mind that you don’t want to do this with just one or two customers. Instead, you want to create a list of the high-dollar receivables from accounts receivable that are less than 15 to 20 days old. You will then go through the list and take off those that you don’t want to receive the discount offer or that will not be able to pay early based on their history.
Using our payment discount calculator, you can then determine the range that you are willing to offer the company in terms of the percentage you can deduct from the invoice. Then, you will simply contact the customer over the phone and let them know about the discount. You can then negotiate with them to get to a number that is agreeable to both parties.
This costs you very little, it makes the customers happy, and it provides you with faster access to cash that your company needs right now.
Strategy #2: Payment Discounts to Lower Risk and Avoid Bad Debt
This is another strategy that your company might need to use in some circumstances. It is more specific, so it will not be used as much as the first strategy, but it can be valuable when dealing with certain clients.
This can work well when you have a client, or clients, who have had payment issues, or who could have payment problems in the future, and who have a large invoice.
If you worry that the customer could be at risk of becoming insolvent, it could be a good idea to offer them a discount as soon as possible. This makes it more likely that you will be able to receive the money owed to you.
If you wait, there is a chance that the client could file for bankruptcy or go into structured liquidation, for example, which means your company will likely be out of luck.
If they liquidate, you will probably not receive anything. Their banks and secured creditors will get the money and assets. If they go through bankruptcy, you will be lucky if you get 15% of what is owed. It is typically much less.
This is especially helpful when those clients have an invoice of $50,000 or more. You do not want to have that money vanish into the ether. Therefore, you need to offer them a discount. This discount needs to be large enough for them that it makes sense for them to pay you.
If you are fortunate enough to notice that the client’s company is having problems at an early stage, you will want to act and provide a payment discount offer right away. There is a better chance of collecting early on.
Additionally, you want to do this before others start to get wind of the client’s troubles. When others hear about problems, you can be sure they will also be trying to collect the money owed to them.
It is also important to remember that your customers and clients in these cases are struggling. They’re not likely to be lured by a small discount of 1% or even 2%.
Instead, you are probably going to want to offer a greater discount. It might be as much as 5%, 10%, or more. You want to get as much of your money back as possible, so offering a larger payment discount to these customers is often the only way to do it.
Strategy #3: Generate Financial Gains with Early Payment Discounts
This third strategy for early payment discounts can help your company to attain more financial success. While the previous two methods helped to provide your company with protection, this option will help improve the profits for your business.
This method tends to work well with customers who pay slowly and who have large invoices. Typically, this will be corporate customers that have excess cash.
You will find that many of the larger customers you have will appreciate the payment discount options that you can offer them. You will need to find your breakeven point and then create pitches that you can use when you are making the offers to these customers.
Keep in mind that different types of customers and clients will likely need a different approach to sell them on the idea of paying early to receive the discount. You know your customers better than anyone else, so be sure to craft your pitches to them accordingly.
As with other payment discount options, this works quite well when the business interest rates are going up. With higher interest rates, it can become more profitable for you.
Consider this proactive approach
The strategies above provide your company with the capability to shorten the credit cycle and to help keep the costs down. Having faster cash flow, and not worrying as much about customers not paying helps the company to get better returns.
It’s a simple method that provides many benefits. The discounts are small, relative to the benefit, so they will not be detrimental to your company, but they serve as a wonderful enticement for the customers and clients.
Take the time to develop a system that utilizes the right strategies and that will work for your current finances. Many companies will find that offering these discounts will help to provide them with better and more stable cash flow.