Lessons learned
Private school hopefuls begin their search at new expo in Calgary
A common recommendation to shorten the time it takes to receive payment from your customers is to offer a discount for early payment. Intuitively, this makes sense. Provided the opportunity to save money, why would a customer not pay early? The difficulty with early payment discounts is not that they do not work, but that they are expensive and often work in ways not intended. Standard payment terms are “net 30” meaning a customer is expected to pay for their purchase within thirty days. As the business owner usually has to pay for the item they have sold before they receive payment, there is a strong incentive to receive payment for the sale as soon as possible. It’s easy to see the attraction of offering a small discount to receive payment as much as three weeks sooner. However, before implementing a discount policy – which, once in place, will be very difficult to remove – certain things should be considered. First, what are you trying to achieve by offering a discount. Are you trying to speed the receipt of cash by customers who otherwise pay on time or are you trying to motivate slow paying customers to pay more quickly. These may seem similar, but they really are not. A customer who pays on time will pay sooner if the benefit of paying earlier (the discount) is greater then the cost of borrowing money to replace the money paid to receive the discount. A customer who pays late is using your business as a means of short-term financing. By not paying you, they are able to use your money for other things. Most likely they are having cash problems, are unable to raise other sources of financing and cannot pay you earlier, regardless of how attractive your discount is. A common discount is “2%/10 net 30” meaning that your terms are 30 days but customers who pay within 10 days receive a 2% discount. Instead of offering a discount to receive your money twenty days sooner, you could have borrowed the money for twenty days, paying it back when the customer pays you. The cost to borrow this money needs to be compared to your discount. In this example, • GST preparation • Payroll • Pickup and delivery
for business • Tax preparation
and advise • Financial statement
preparation offering a 2% discount to receive payment twenty days early is the same as borrowing the money for twenty days at an annual interest rate of 37%. Expensive to say the least! Combine this cost with the tendency of good customers to take advantage of discounts and slow paying customers to not and discounts are not nearly as attractive as they may have seemed. Should discounts ever be offered? As costly as they may be, there are times when they may be needed. Industry practice will play a major role in any decision. What are your competitors doing? Will not offering a discount put you at a disadvantage? Is the early receipt of cash critical to the continued operation of your business? Are other sources of financing available? Obviously, if you must offer a discount, you should offer as small a discount as possible for receipt of payment as early as possible. • Operation, internal controls efficiency and business process audits • Business advice