Before offering a prompt payment discount, it’s worth understanding how to structure it effectively, how to calculate it correctly, and how VAT applies. In this article, we’ll cover the key considerations, how different businesses use prompt payment discounts and how the right tools can help strengthen your cash flow.
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For many businesses, managing customer payments is a careful balancing act. Offering trade credit and extended payment terms is a valuable way to win and sustain business relationships, but when invoices aren’t settled on time, you can often find yourself waiting for funds you need to cover at your own expenses. One common way to speed up your trade receivables is by offering a prompt payment discount.
In essence, it rewards buyers with a small discount if they settle their invoice before the due date. For suppliers, this means improved cash flow and reduced credit risk. For buyers, it means lower costs and smoother relationships.
A prompt payment discount, sometimes called an early settlement discount or early payment discount, is a financial incentive offered to customers who pay their invoice before the standard due date. It’s typically expressed as a percentage reduction in the invoice amount if payment is made within a specified timeframe.
The most common format used in payment terms on an invoice is written as X/Y, net Z, where:
For example, a supplier offering 2/10, net 30 means the customer can take a 2% discount if they pay within 10 days. Otherwise, the full amount is due within 30 days.
This type of discount is particularly common in industries where getting paid quickly is particularly important, such as manufacturing, wholesale distribution, and construction. By offering a nudge for early payment, businesses reduce the likelihood of overdue invoices and improve their day to day liquidity.
You calculate a prompt payment discount as a percentage of the value of goods and services purchased, then include it on your invoice, as the ‘percentage/time in days it applies’ such as 2/10, meaning customers that pay within 10 days get a 2% discount.
When offering a prompt payment discount, the calculation must be clear and consistent in your payment terms. The formula is:
Discounted price = invoice amount × (1 - discount percentage)
Making your terms clear ensures that both the business and the customer understand the exact amount due if the discount is applied.
Let’s use an example to make it clearer. Say a wholesale supplier issues an invoice for £5,000 with 2/10, net 30 terms.
If the customer pays within 10 days, they qualify for a 2% discount.
The discount is calculated as:
If they pay after 10 days, they must pay the full £5,000.
Another way to structure your discounts is by using a sliding scale to encourage clients to pay earlier to save more, with the discount percentage falling as time passes.
For instance, a supplier might offer:
This allows buyers more flexibility while still encouraging early payment. It also helps suppliers manage cash flow by prioritising payments from customers who need a greater incentive to settle invoices early.
Businesses operating in the UK need to be aware of the VAT implications when offering a prompt payment discount.
Under UK VAT regulations, businesses must charge VAT on the full invoice amount at the time of issuing the invoice, regardless of whether a prompt payment discount is later applied.
If the customer takes the discount by paying early, the supplier must issue a credit note to adjust the VAT accordingly for accurate payment reconciliation.
Remember: it’s up to the supplier to record these adjustments to remain compliant with HMRC rules. If you make a mistake in applying VAT you could be liable for a penalty.
Offering a prompt payment discount can be an effective way to improve cash flow and reduce outstanding debts, but that doesn’t mean that it’s automatically the right choice for every business. Let’s take a look at the pros and cons.
Before using discounts, it’s worth taking a look at your historical payment data to see if it’s worth it. If most customers already settle invoices promptly, the benefit may not justify the cost.
A well-structured prompt payment discount should strike a balance between incentivising early payment and maintaining profitability.
Manually managing prompt payment discounts can quickly become time-consuming, particularly for businesses with a high volume of invoices and customers. Automation tools help streamline the process by:
Using digital payment solutions, such as iwocaPay or other fintech platforms, allows businesses to integrate payment discounts directly into their invoicing systems, reducing administrative burden and improving accuracy.
Businesses should be mindful of common pitfalls that can reduce the effectiveness of a prompt payment discount strategy.
A prompt payment discount can be a handy tool if you’re looking to improve cash flow, reduce late payments and build stronger customer relationships. But while offering a discount encourages early payment, it also introduces additional administrative work and cuts into profit margins if you’re not careful. That’s why it’s important to weigh the benefits against the potential loss in revenue and the complexity of managing VAT adjustments.
A B2B Buy Now, Pay Later (BNPL) solution like iwocaPay offers a way to provide flexible payment terms to customers, without the risk of late payments or the need to offer discounts that eat into profits.
Instead of waiting for invoices to be paid, you can get paid upfront, while your customers can spread the cost over time.
For B2B businesses who want to get paid instantly while offering flexible payment terms.
For trade customers who want to increase their purchasing power while keeping control of their cashflow.
