There are considerable variations in the methods of payment among different types of businesses. Some firms require immediate payment, while others allow their customers to pay bills within a specified period known as the credit period. If used properly, cash discounts also known as purchase discounts can improve the days-sales-outstanding aspect of a business’s cash conversion cycle.

Many companies offer their customers a discount from the selling price called a cash discount. A cash discount is also called a sales discount by the seller, and a purchase discount by the buyer. Such a discount is to induce an early payment before the expiration of the credit period.

Among reasons to offer cash discount are:

1. To collect receivables quickly. Providing a small cash discount would be beneficial for the seller as it would allow him to have access to the cash sooner. The sooner a seller receives the cash, the earlier he can put the money back into the business to buy more supplies and/or grow the company further.

2. Faster collections reduce debts.
3. Sellers can pay their own bills and hence reduce interest costs.
4. Competitiveness.
5. To finish old stocks/unsalable goods/poor conditioned stocks.
6. To encourage goods sold in bulk/large quantities.

In general, a cash discount term is written as “2/10, n/30”. It means if a payment is made within 10 days from the date of the invoice, a 2% cash discount is allowed, although the debtor is permitted a period of 30 days to pay the bill. However, if the bill is paid after the end of 10 days but on or before the end of the 30-day period, the net amount of the invoice must be paid. After 30 days, the bill will be considered overdue and may be subjected to an interest charge.

However, note that freight costs are not subject to cash discounts and need to be deducted from the invoice.

4.3.1 The Formula

The amount of cash discount is given as:

Cash Discount = Invoice amount (or selling price) x Cash discount rate (%)

Subject to a few conditions, such as:

Normal date: 2/10, n/30.

End of the Month (E.O.M.): 2/10 E.O.M.

Received of Goods (R.O.G.): 2/10 R.O.G.

E.O.M means the discount period starts from the end of the month instead of the invoice date.

R.O.G. means the discount period starts from the date of receipt of the goods.