Business are often offered a discount by their suppliers if they will pay earlier than arranged for goods already supplied but sometimes, it's better for the business not to take that discount. This presentation shows how to calculate whether to take the discount or not.

1. How to calculate the cost
of not taking an early
settlement discount
from
businessbankingcoach.com
in association with

2. Suppliers sometimes offer discounts to their
customers for early payment of trade debts
outstanding – but there are times when it’s
better not to take them
What? How can
it be better not
to take a
discount?

3. Here’s the scenario;
A business has bought product from its
supplier and the supplier allows 30 days
credit.
But there is an option - the invoice includes
this phrase: Terms 2/10 net 30 days
That means if you
pay me in 10
days instead of
30, I’ll give you a
discount of 2%

4. To put that another way,
the business will pay the full amount of
the invoice, i.e. 2% more than it needs
to, if it waits for the full 30 days period to
elapse before making payment instead
of paying within the 10 day period.
So there is a cost to the business of not
taking that discount.

5. Now, suppose that the
business wants to take
advantage of the
discount but doesn’t
have cash available.
It will have to use an
overdraft to pay the
amount owing

6. The question is;
“which option will be
cheaper – use the
overdraft and pay
early to get the
discount ........or forget
the discount and save
the interest cost of the
overdraft?”

7. Luckily, there’s an easy formula to work that
out. All you need to know is;
The discount on offer – in our scenario that’s
2%
How many days there are between the early
payment date and the normal due date – in
our scenario that’s 20 days (30 days
originally minus the 10 days new period to
qualify for the discount)

8. The formula then is;
2
x
365
= 37.24%
98 20
The
percentage
discount
100% minus the
percentage
discount
Number of days
between early
payment date and
normal due date

9. So this tells us that the annualised cost
of not taking the discount is 37.24%

10. The business then needs to compare
that with the interest rate charged on its
overdraft
Whichever rate is lower is the best for
the business from a cost point of view

11. So, in our scenario,
the cost of not taking the discount is 37.24%
the interest cost of an overdraft is, let’s say,
15%
The lower of the two is the
interest cost of the
overdraft so that’s the best
option – use the overdraft
to get the discount

12. .............provided that the
cash will not be needed
by the business for any
other purpose
That’s correct!