Are you wrestling with the decision whether to offer Cash Discounts for early payment as an alternative payment term for your company? It is an important decision because Cash Discounts can have a significant impact on cash flow and the cost of financing and collecting accounts receivable.
Here are the pros and cons of offering Cash Discounts that you should consider in making your decision.
Offering Cash Discounts for early payment can help you to reduce DSO. The value of a Cash Discount to a customer can be a big incentive for early payment. For example, if you offer payment terms of 2% 10, Net 30 days, the opportunity cost to your customer of not taking the Cash Discount is approximately 36% (360/20 X 2% = 36%) assuming they would otherwise pay your invoice in 30 days. The benefit of paying 20 days early is 36% on an annualized basis.
The corresponding reduction in DSO in this example could be quite substantial if a large portion of your AR is paid 20 days early. Reducing DSO decreases the investment your company needs to make in customer AR, and frees up cash for inventory purchases, operating expenses and investments for growth.
Accelerates Cash Flow
Cash Discounts accelerate cash flow by pulling payments forward. In the preceding example, cash would be pulled forward by 20 days on the invoices paid early. Consider the significant benefits your company could reap from 20 days of cash flow!
Offering Cash Discount terms may make your company a more attractive choice for potential customers. The benefits of gaining new customers would more than offset the cost of a Cash Discount.
Conversely, your competition may offer Cash Discount terms, which you may also need to offer to remain competitive. The cost of offering a Cash Discount would be far less than the profits lost from losing a customer to competition.
Lowest Net Price
Cash Discounts are accounted for as a reduction in sales revenue by the seller resulting in a lower net selling price and gross margin. So effectively you are trading a lower net price and gross margin to reduce DSO and accelerate cash flow.
Regardless of how Cash Discounts are accounted for they result in a real economic cost in the form of profit sacrificed to reduce DSO and accelerate cash flow.
Cash Discounts can be one of the tools that you choose to reduce DSO and accelerate cash flow. Careful consideration needs to be given to the pros and cons before making a final decision to offer Cash Discounts.
While Cash Discounts can be helpful tool in reducing DSO, they will not provide the overall solutions you need to monitor and control DSO. The technology available in automated accounts receivable and collections is what you need to give your AR team the resources needed to stay ahead of the curve on DSO.
The key to successfully automating accounts receivable and collections is to work with an experienced software partner.
Lockstep Collect is a market leader in cloud-based credit and collection platforms. Lockstep Collect can help you implement the technology applications you need to reduce and control DSO.
If you would like to learn more about how you can benefit from automating collections and accounts receivable, please contact Lockstep Collect at www.lockstep.io.