Friday, November 18, 2011

Prompt Payment Discounts

Suppliers may offer buyers prompt payment discounts in the quotes such as 2% 10, Net 30.
The means that if the buyer makes payment in 10 days there is a discount of 2%, otherwise payment is due net thirty days.

When a supplier offers a prompt payment discount that means that they have a cost of money or value of money that is higher than the amount of the discount they offered. In deciding whether to accept a prompt payment discount there are several things buyers need to consider.

The first consideration would be whether the buyer’s company has the available cash to make such a payment. The second is whether from a cost or value of money the buyer’s company has, is it financially worth paying the supplier sooner? Without taking compounding into account, In the example of 2% 10 making payment twenty days early is worth .1% a day (2% divided by 20). On an annualized basis that equates to 36.5%, This should tell you that the supplier has a high need to cash. So if your company’s cost or value of money was less that this, you might consider the prompt payment discount.

The last consideration is the potential impact the prompt payment would have in the event there was a problem with what the supplier delivered. Normally you do not want to make payment before you have the ability to test or inspect what the supplier provided to make sure than it isn’t defective and that it meets the required specifications, scope or work or statement of work.

If making a prompt payment and taking the discount won’t give you the time to do those inspections or tests, the amounts you can lose and the problems that can arise because they already have your money can be substantially more costly that what you may have saved.
The simple fact is you always have more leverage to correct any problems before you make payment rather than after.

This doesn’t mean that I wouldn’t agree to take a prompt payment discount, I would just want to make sure that I trust the supplier to promptly correct any problems. What this also requires is procurement needs to work with your accounts payable group to make sure that they are not automatically take a prompt payment discount without your agreement. You don’t want them creating a problem for you just because a prompt payment discount is on the suppliers invoice and it meets the appropriate rate.

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  1. Hard to understand the meaning trying to get across. Need to simplify the English and ensure you have not made any typos.

  2. Dear Anonymous,
    Both buyers and sellers have a cost of money. Their cost of money is either the cost they would need to pay to borrow the money or the amount they could make if they were to invest the money.

    The cost of money for both parties may be different. When you are offered a prompt payment discount the supplier wants to be paid earlier. The see a benefit in getting the payment earlier and offer the discount to try to get early payment. They may want early payment to help finance operations rather than needing to borrow as borrowing could cost more than the discount. Whether that discount makes sense to you will depend upon your cost of money. For example you would never take a discount if your cost of money is higher than that the discount. In large companies the treasury or finance group's frequently publish how high the discount percentage must be for it to make financial sense to pay early.

    The other aspect of the comment is the risk that you have in making payment before you have the ability to physically inspect the product. That can occur if payment is tied to the date of shipment, and payment must be made prior to the receipt of the goods due to transit times.