Frequently, suppliers will give invoice payment terms that include an early payment discount. Most often, this is done to accelerate cash flow to the supplier. The invoice will typically contain terms such as “2%/10, net 30.” This is just an example – the range of discount percentages and time periods run the full gamut. For discussion purposes, though, we’ll use “2/10, net 30” terms as an example. What this means is that the customer will get a 2% discount off of the invoice amount if that invoice is paid within 10 days of the invoice date. If the discount is not taken, the full amount of the invoice is due “net 30” days from the invoice date.
Some of us may say: “only 2% – that’s nothing, why bother?”
Well, let’s examine this a little further. Let’s assume that we don’t take the 2% discount and we pay the full invoice amount in 30 days. By not taking the discount, we are effectively “paying” 2% for the use of that invoice amount for 20 days (the difference between the 10-day discount period and the ultimate 30-day due date). For the real gear heads out there, it’s actually 2.041% – 2 divided by 98.
OK, so we’re paying 2% for the use of that money for only 20 days. Next, let’s annualize that interest rate. There are roughly eighteen 20-day periods in a year, so we are effectively paying an annual interest rate of about 36%, aren’t we? [2% times eighteen 20-day periods] Ouch! To make matters worse, if your accounts payable department pays the invoice earlier than 30 days, you’re paying 2% to use that money for a shorter period of time. The interest rate math gets ugly fast!
So, the moral of the story is: cash flow permitting, always take advantage of early payment discounts offered by your suppliers! There are even some working capital management experts that advocate taking early payment discounts whether you pay within the discount period or not. Appropriateness aside, the thinking here is that few businesses will actually invest the time and energy to go back and recover the discount that was “erroneously” taken by the customer.
It’s time to put an end to paying “credit card” interest rates to your suppliers – take those discounts!