A cash discount is a reduction in the price of a product or service offered by a seller to the buyer as an incentive for making a payment promptly or within a specified time frame. Cash discounts are typically expressed as a percentage of the invoice amount and are applied when the buyer pays the seller earlier than the agreed-upon payment terms.
The main objective of offering cash discounts is to encourage buyers to pay their invoices sooner, which helps the seller improve cash flow, reduce the risk of bad debts, and decrease the time and effort spent on collections. For the buyer, taking advantage of cash discounts can result in cost savings and better management of their own cash flow.
A common cash discount term is “2/10, net 30.” This means the buyer can take a 2% discount on the invoice amount if they pay within 10 days, but the full payment is due within 30 days. If the buyer does not take advantage of the cash discount, they are expected to pay the full invoice amount within the specified 30-day period.
Example of a Cash Discount
Let’s consider a hypothetical example involving a wholesale electronics store, “Gadget Wholesaler,” and a retail store, “Tech Retailer.”
Tech Retailer places an order with Gadget Wholesaler for electronic devices, and the total invoice amount is $10,000. Gadget Wholesaler offers cash discount terms of 3/15, net 45 on the invoice, which means Tech Retailer can take a 3% discount if they pay within 15 days, but the full payment is due within 45 days.
Here are the two payment scenarios for Tech Retailer:
- Tech Retailer decides to take advantage of the cash discount. They pay Gadget Wholesaler within 15 days, which entitles them to a 3% discount on the invoice amount.
The calculation for the discount is:
$10,000 * 0.03 = $300
Tech Retailer pays Gadget Wholesaler $10,000 – $300 = $9,700 within 15 days.
- Tech Retailer chooses not to take advantage of the cash discount and pays the full invoice amount. They are required to pay the entire $10,000 within the 45-day payment term.
In this example, by offering a cash discount, Gadget Wholesaler encourages Tech Retailer to pay their invoice promptly, which improves Gadget Wholesaler’s cash flow and reduces the risk of late payments or uncollected debts. On the other hand, Tech Retailer can save $300 by taking advantage of the cash discount, which reduces their purchasing costs and helps them manage their own cash flow more efficiently.