Small Business? Consider Prompt Pay Discounts
Prompt pay discounts are at the center of introductory accounting class problems and small businesses across the nation. If you are in a line of business that provides customers a bill after a service is performed (as opposed to taking cash up front), you need to consider how the delay in payment affects your business. For example, if a customer's payment is due on the 20th but you need to pay your employees on the 15th, you better have enough cash on hand to pay those employees. This is where the prompt pay discount comes into play: by offering your customers a slight discount for paying promptly, you can increase your rate of collection and avoid the hassles that come from being short on cash, all for the price of that discount. This discount may vary depending on the industry you were operating in and the customers you deal with.
Most often payment terms will be something like: “2/10 Net 30”
This means that the customer pays within 10 days, they will receive a prompt pay discount of 2%, and if they fail to pay within that 10-day period, the whole invoice is due in 30 days. For example, if your company has a $10,000 invoice out to a customer with these terms, they could pay in 10 days and only need to pay $9,800.
Why Should I Offer Prompt Pay Discounts?
Prompt pay discounts are a great example of incentivizing customer behavior to benefit your business in the long run, even if your company is losing some money to make it happen.
Discounts feel good. When a customer has the ability to get themselves a discount by paying promptly, they're more likely to take advantage of it. By doing so, the customer is simultaneously rewarding themselves for making a good decision and saving money, as well as helping your company's cash flow.
Cash flow is essential for small businesses. I have many clients that view their entire business on the cash basis, not because they are reporting on the cash basis (they don't, they report on the accrual basis), but because the operations of the company are driven by what cash is on hand. Some business owners do not like to consider certain types of financing for their company because it will add interest and other requirements (like getting an audit) that they might not want to deal with. For them, the best way to avoid this hassle is to make sure that the company has enough cash to operate and then make decisions based on the available cash. By giving customers a discount for paying early, the business owner is giving themselves more flexibility to run their business the way they want to - with cash in hand. This is even more important for smaller businesses that don't have access to such financing, because the only way for them to get more cash to grow the business is to collect it.
If your business model revolves around sending and collecting invoices, give this a try. It may just give you the cash you need to make your next big move sooner.