A payment discount, also known as ‘discounts for prompt payment,’ can be a great way to get invoices paid faster and improve your accounts receivables process.
However, these discounts should not be offered indiscriminately - they need to be carefully calculated and implemented in order for them to work effectively.
There is some debate on whether they should be standard practice in order to incentivize customers to pay early, or whether they should be used as a last resort measure when other methods of collection have failed.
In the instance that your business can afford it and you want to introduce early payment discounts this blog outlines how to implement early payment discounts so that you can start seeing results!
What is an early payment discount?
Early payment discounts are a way to reward good payment behavior, functioning as the carrot, where late payment fees are the stick to discourage poor payment behavior.
There are a few different types of early payment discounts, but the most common are volume and time-based discounts.
Volume discounts offer customers lower prices for making larger payments upfront, while time-based discounts offer customers a reduced price if they pay within a certain number of days or weeks from when the invoice is issued.
Time-based discounts are the most common, as they encourage customers to pay quickly by giving them a financial incentive to do so.
However, it’s important to make sure the time-based discount is long enough that customers have time to actually pay their invoice, but also short enough that you don’t lose out on too much revenue by giving the discount.
How to calculate an early payment discount
When it comes to calculating your early payment discount, there are two primary options, static or dynamic discounting.
Static discounting
In static discounting, you offer a set discount for early payment, regardless of how quickly the invoice is paid. This can be advantageous as it’s easy to understand and calculate, but can also limit your revenue if customers take their time to pay.
For example: If you have the usual Net 30 payment terms, you might offer a 1% discount if they pay in the first ten days.
Dynamic discounting
Dynamic discounting takes into account how quickly the invoice is paid, offering a larger discount the sooner it’s paid. This can encourage customers to pay quickly, as the discount gets larger the sooner they pay.
For example: If you have the usual Net 30 payment terms, you might offer a 0.5% discount if they pay in the first ten days, then a 0.25% discount for payments in 11-20 days, and so on.
To implement an effective prompt payment discount strategy, you will need to ensure your invoice and payment data is being carefully tracked. To do this, we recommend having an accounts receivables automation system in place, if not, you can use this free invoice tracking template for Google Sheets and Excel.
How early payment discounts impact your business
When used strategically, early payment discounts can have a large positive impact on your business, including:
Faster invoice payments
Late payments are one of the most prevalent problems for small businesses. Around one in every ten invoices are paid late and 10% of payments are either never paid or written off as bad debt.
This can have a crippling impact on businesses and their cash flow, which is why it can be beneficial to implement an early payment discount plan to encourage faster payments.
Getting invoices paid sooner means your cash flow will improve and you'll be able to reinvest in your business sooner. With your business offering a discount for early payments, your invoices are likely to move to the front of any payment queue.
Customer benefits
While getting paid on time does very much benefit your business, it's also important to remember the customer. Offering early payment discounts can help you win and keep customers by offering them benefits as well.
Any discount on an invoice you send will improve the profit margins of your customers. This will make your customers more willing to pay on time, as you can offer them a discount incentive.
Offering an active reward for good payment behavior also shows that you value your customers and their business - a gesture that is sure to be appreciated.
In addition, it can also help improve your company's public image as an organization that is willing to work with its customers for the benefit of all parties involved.
Good customer relationships are vital to small businesses in the current climate, with many businesses experiencing a very competitive marketplace. Offering quid-pro-quo benefits is one way of differentiating your business from the competition and cementing customer loyalty.
Reduced revenue
Although early payment discounts can mean faster payments, better cash flow, and improved customer relationships, one of their primary downsides is that it can have a direct impact on your business's revenue. The more of a discount your offer, the less money you have coming in.
It's important to consider the potential revenue you may be giving up, but also how much of a difference early payment discounts could make in your cash flow.
If you are planning on implementing an early payment discount, always consider what your business can afford and make sure that the discount is worth more than the cost of loss. Modeling various scenarios, such as best and worst case after the implementation of early payment discounts will be beneficial in helping you decide if this is a strategy your business should adopt for faster invoices payments.
How to implement an early payment discount
Implementing an effective early payment discount scheme requires careful consideration and planning. However, there are a number of simple steps that can be taken to ensure the process goes smoothly:
1) Decide on your discount period
Your early payment discount should have an expiry date after which it is no longer applicable to current invoices.
In addition, you may wish to only offer this discount during certain times of the year or when circumstances in your business dictate (e.g., do not apply discounts if cash flow is tight).
This will allow for greater flexibility with regards to how much you give away as a company and also reduce accounting complexities caused by offering multiple variations on early payment discounts across different products/services at any given time.
So, your early payment discounts should have an expiry date after which they are no longer applicable to current invoices, in order to maintain control over the company's cash flow and accounting complexities. These discount periods can be set out in your business’ payment terms and within your credit control policy to ensure your internal team are aligned on the terms of your early payment discounts when discussing them with customers or applying them to invoices.
2) Empower staff to offer discounts
One option to make your early payment discount process more customer-friendly and use this as a tool to foster new, or improved customer relationships is to give staff members who deal directly with customers some leeway on what discount to offer.
Have some leeway on what discount they can offer, as long as it's still within the boundaries of your company policy, to allow your staff to be more flexible and accommodating to customers.
3) Make it easy for customers to pay early
If you want customers to pay their invoices earlier, make the process as simple as possible for them. This could include providing a range of payment methods such as online payments, direct debit, or even installment plans.
Offer different ways for your customers to pay their bills so that they can find the most convenient option for them. This will encourage them to take advantage of your early payment discounts.
4) Categorize customers to decide who to offer discounts to
Rather than offering discounts to all of your customers, you should categorize customers into groups of those who it would be worthwhile to offer early payment discounts to, and those who it wouldn’t.
For example, consistently good payers may not need this extra nudge to pay early, whereas customers who have been late paying in the past may need a discount to make them feel compelled to start making payments early.
However, those customers who show consistently poor payment behaviour should be informed of your late payment penalty terms and conditions in an effort to encourage them to pay on time.
When deciding whether or not to offer early payment discounts, you should also consider the size of each order.
Offering a discount for larger orders may entice customers to make bigger purchases, while smaller orders may not warrant a discount. The caveat to this is that the larger the order, the larger bite a discount on that order is going to take out of your bottom line.
Getting the balance right on early payment discounts is all about striking a balance between encouraging your customers to pay early while not putting yourself at a financial disadvantage while doing so.
5) Communicate early payment discounts with customers
Once you have decided on your discount method, period, and which clients to offer them to, you are ready to inform your customers about your early payment discounts.
We recommend including a notice of your early payment discount in a polite payment reminder email, such as your before due email to customers, and invoice copy emails.
Ensure your customers are made aware of this when their invoice is issued, and remind them when the end of their discount period is approaching.
Get paid faster with early payment discounts
There are many benefits of implementing an early payment discount policy in your business, from improving your cash flow to winning and keeping customers. But before making any decisions, always consider what your business can afford.
An effective accounts receivables platform is an excellent way to collect the data on which of your customers to offer early payment discounts to.
Chaser, for example, collects all your customer's payment data in one place. By setting up an accounts receivables process with relevant case types in Chaser you can then offer an early payment discount to customers who meet these criteria.
To find out more about how Chaser can revolutionize your approach to credit control, sign up for your 14-day free trial, no payment details required!
