Cash discount – What is a cash discount?
A cash discount is an incentive offered by a seller to a buyer for paying an invoice ahead of the scheduled due date
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Cash discounts are incentives offered by sellers that reduce the amount that the buyer owes by either a percentage of the total bill or by a fixed amount.
For example: If an invoice is due in 30 days, a seller could offer the buyer a typical cash discount of 2pc if they were to pay the invoice within the first 10 days of receiving it.
Small cash discounts benefit the seller because they increase the likelihood that a buyer will pay quickly, therefore providing the seller with cash in a shorter period of time, as it is better to receive e.g. 95% of an invoice with a few days than wait 30 or more days to receive the full amount.
Having cash sooner means that the seller can in turn put the cash back into the business sooner – a good motivation for any organisation.
How cash discounts work:
An example of how a cash discount is applied:
- Net price of goods: £200.00
- VAT Calculation:
- Goods £200.00
- Less 10% cash discount (£20.00)
- Goods after cash discount £180.00
- VAT @ 20% of £180.00 = £36.00
- Gross Invoice total £216.00
If, as a supplier, you offer a cash discount on condition the invoice is paid early or within a specific time frame the VAT can be calculated on the basis that the discount will be taken so the VAT will be a percentage of the net amount after discount.
Cash discounts vs. trade discounts
Cash discounts are not reductions in the agreed sales price of the goods or services at the time of the transaction – they are a reduction in the amount to be paid by a credit customer (to whom you have given credit terms) if that customer pays within a specified time period.
A cash discount is intended to persuade credit customers to pay their bills quickly – not an incentive to make the purchase.
Cash discounts: shorthand
In accounting, usually the discount amount and the time period within which it is available, are expressed in a format such as 2/10, n/30. This means a 2% discount if the invoice is paid within ten days, otherwise the payment is due in its entirety within 30 days.
Recording cash discounts: net vs. gross method
In accounting, there are two different ways that cash discounts can be recorded in the books: the net method and the gross method.
The net method treats sales revenue as the net amount after the given discount, and any discounts that the buyer doesn’t take are recorded as interest revenue. The discounts are essentially treated as compensation to the seller for providing credit to the buyer.
The gross method views discounts that aren’t taken by the buyer as a portion of total sales revenue – not as separate interest earnings. The gross method is the most common in business practices today.
No matter which recording method is used, a cash discount taken by a buyer will reduce sales revenue.
Cash discounts and Debitoor
Debitoor’s online invoicing software allows you to add discounts directly to the subtotal of your invoices and takes care of the calculation for you. You can set the percentage and include the terms in our convenient invoice templates.