What does an early-payment discount cost you to decline?

An invoice can offer two prices for the same goods: a lower amount paid early or the full amount paid later. Keeping the money for longer has a cost even when the invoice carries no separate interest charge. Start with the cash you keep, the extra amount you pay and the time between the two payment dates.

Two prices, one invoice

Consider an invented $18,000 supplier invoice with these agreed terms: pay $17,820 on day 10, or $18,000 on day 40. The goods are already delivered and accepted. There are no returns, disputed charges, other fees or taxes in this example. The parties have confirmed the payment deadlines and when cleared funds must arrive.

The buyer gets a 1 percent discount for paying thirty days sooner. The discount is $180: 1 percent of the $18,000 invoice. Waiting from day 10 to day 40 keeps $17,820 available for thirty more days, then requires $180 more.

The cost for that interval is $180 divided by $17,820, about 1.01 percent for those thirty days, not an annual rate. Dividing by $18,000 answers a different question: what percentage of the invoice is discounted? The business deciding whether to wait is retaining the smaller amount it could otherwise pay on day 10.

ACCA's trade-credit explanation identifies the loss of an early-payment discount as a possible cost of supplier credit. An agreed later payment is different from missing the final due date.

The discount can expose an earlier gap

The buyer has $20,500 available on day 10. It must pay $4,000 on day 18 and expects a $12,000 customer receipt on day 35. These are the only other cash movements through day 40. Assume that receipt arrives in full.

Paying $17,820 from the bank leaves $2,680. That is $1,320 short of the day-18 payment. Paying the supplier early saves $180 but does not leave enough money for the supplied schedule.

Waiting until day 40 keeps $20,500 in the bank on day 10. The day-18 payment leaves $16,500; the customer receipt raises it to $28,500. Paying the $18,000 supplier bill then leaves $10,500. This route meets every stated payment without new borrowing.

Compare an available alternative

Now add one fully specified financing offer. On day 10, a lender will advance the full $17,820, with a single $17,940 repayment on day 40. There are no withheld charges, interim payments or other fees or obligations under this invented offer. Its complete cash cost is $120.

The buyer can receive the advance and pay the supplier on day 10 without using its existing $20,500. It can then pay the $4,000 bill and receive the $12,000 as before. On day 40 it has $28,500 before the $17,940 repayment, leaving $10,560.

That is $60 more than waiting to pay the supplier. The $180 discount has paid for $120 of financing, leaving $60. It has not created an extra $180 on top of the borrowed money.

A fee increasing the financing cost to $180 would remove the difference. A cost above $180 would leave this route with less cash than the full-price supplier payment, assuming the same dates and all other stated conditions. The comparison is between complete cash schedules, not between a 1 percent discount and a lender's unrelated annual headline rate.

What is actually available?

The financing offer is supplied for the example. A real business still needs an available offer, its net advance, all required payments and any restrictions attached to it. A calculation cannot supply an approval or make a borrowing arrangement acceptable.

The customer receipt also remains important. If it arrives after day 40, the buyer has $16,500 after the day-18 payment. It is then $1,500 short of the supplier balance or $1,440 short of the lender repayment. The $60 advantage has not insured either route against late collection.

For one invoice, write the discounted amount beside its last payment date, then the full amount beside its due date. Compare the money retained between those dates with the extra payment. Put any actual alternative into that same calendar. The discount can be worthwhile and still require cash the business cannot spare.

For the wider business decisions behind payment terms, find your starting point in Infinite Upside.