In this FAQ, you'll discover whether your business should use or provide early payment discounts effectively.

Many businesses encourage early payments by offering discounts to clients who settle their invoices ahead of schedule. But is it financially beneficial to take advantage of these offers? In most cases, yes. Early payment discounts can be a smart way to maximize your resources, making it worthwhile to allocate extra cash or even consider short-term borrowing to benefit from them. However, they’re not universally beneficial. Whether these discounts are right for your business depends on several key factors, such as your expected return on investment (ROI), the cost of financing, and the state of your cash flow. Here’s a closer look at how to evaluate whether taking — or offering — early payment discounts aligns with your business strategy.

Understanding Early Payments Discounts

Early payment discounts are incentives offered by suppliers to encourage quicker payment of invoices. By paying earlier than the due date, clients benefit from a reduced invoice total, and suppliers enhance their cash flow.

For instance, a supplier may extend a 2% discount if payment is made within 10 days rather than the standard 30-day window. For an invoice of $1,000, the customer would pay $980 if they settle within 10 days, saving $20.

The Financial Calculations Behind Discounts

Let’s break it down: imagine a supplier offers a 2% discount if an invoice is paid within 10 days instead of the usual 30. This is often referred to as "2%/10 net 30." Opting for the discount means foregoing access to your money for 20 days in exchange for saving 2%.

That 2% savings over 20 days, when annualized, translates to a return of approximately 37%. Even a smaller discount, such as 1%/10 net 30, equates to an annualized return of around 18%.

Simply put, paying early is akin to earning interest on your money. Even small discounts can result in significant financial gains when calculated over a year.

To invest or take the discount?

Not all discounts are worth pursuing. Assess your business's return on investment (ROI), financing costs, and cash flow before deciding.

• Take the Discount: If your business ROI or debt servicing costs are lower than 37%, a 2%/10 net 30 discount is advantageous.
• Pass on the Discount: If your ROI exceeds 37% — common in some start-ups — investing the money in your business is likely more profitable. Similarly, if your financing costs are above 37%, paying down debt would be a better use of funds.
• Cash Flow Considerations: Tight cash flow may force you to skip discounts, regardless of potential returns.

When should you provide discounts?

Offering discounts to your clients flips the equation. The high implied cost of providing discounts often outweighs the benefits unless your cash flow is under significant strain or your ROI is exceptionally high.

For instance, offering a 2%/10 net 30 discount would only make sense if your ROI or financing costs exceed 37%. For a 1%/10 net 30 discount, the threshold is 18%. Otherwise, offering discounts could prove costly and unsustainable for your business.

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