Prompt payment discounts offer hidden savings

Vendors may offer a payment term which includes a discount for early payment. The most common version of this is 2% 10, net 30. This translates into a 2% discount off the amount owed on the vendor’s invoice if paid within 10 days of the invoice date. If not paid within 10 days, payment is expected in 30 days, with no discount.

The question I’m often asked is whether or not to take the discount. My answer is always YES! Although a 2% discount sounds insignificant, it is actually a fantastic deal, because of the cost of that money. Let me explain.

Your vendor is offering to discount the bill they sent you by 2% if you pay early. You’re essentially getting a 2% bonus for paying 20 days earlier. If you extended that math out over the course of a year (365 days), it would be equivalent to a 36.5% discount. In other words, you are making 36.5% in interest on that money because you paid early. I don’t know where anyone can make 36.5% on their money nowadays.

If you’re offered a 1% 10, net 30 payment term, you should still take the discount and pay early. This is equivalent to making 18.25% on your money.

You should not borrow money, such as a line of credit, to make the payment unless you’re certain that the money will be available to pay down the line within 30 days. The vendor offering these terms should be given preferential treatment when a finite amount of money is available and you need to decide who gets paid first.

I’ll take this one step further by suggesting that you request a 2% 10, net 30 from vendors that would be willing to go along with it. I’ve recommended this to my client’s vendors with success. If that particular vendor is short on cash, they’ll probably go for the deal. Just one more reason why having cash flow in this economy lets you dictate the rules.

If you’d like a free copy of the Excel spread sheet that performs these calculations, please leave a comment, or fill out the contact form.