Introduction: Understanding Early Payment Discounts and Their Benefits
Early payment discounts are a fantastic and easy way for businesses to manage their cash flow and encourage prompt payment from customers. On the other side of the coin, they can help a business save money on its purchases and reduce payables.
For Accounts Receivable
If your business is struggling to collect debt from customers (you can use the Accounts Receivable Turnover Ratio to get an idea), you might consider implementing an early payment discount program for your customers.
Simply put, you offer your customers a percentage or flat rate discount if they pay your invoice by a certain date. This can incentivize customers to pay faster, thereby improving your company’s cash flow.
A common example is 2/10 Net 30, which means that if the customer pays within 10 days of the invoice date, they get a 2% discount on the total (or net) of the invoice. Otherwise, the full amount of the invoice is due within 30 days.
Alternatively, you can implement a late payment charge, where interest is charged as a percentage or flat fee on any customer accounts that aren’t paid by a certain date (30, 60, and 90 days are common due dates).
For Accounts Payable
And on the payables side, businesses can save themselves a ton of money by taking advantage of suppliers who offer these discounts (or tack on interest).
Let’s say you buy $50,000 worth of product from a supplier in one year. If you’re on top of the payments, you’ll save $1,000 in that year. And you usually get to claim 100% of the GST/HST paid - but of course its important to review the supplier’s bill to verify this.
Not only are there monetary benefits to early payments, but they also help strengthen customer and supplier relationships. You know which customers you can count on for early payment - they’re probably some of your favourites! And we think any vendor that gets a prompt payment is sure to love you!
As you can see, your company can benefit from these early payment discounts. But it’s also incredibly important to account for these properly as they will affect your financial statements. The Canada Revenue Agency has set out rules on how to deal with the tax and total value of the goods and services that will be discounted.
Read on for help on early payment discounts and make sure your company is doing them correctly!
Step-by-Step Guide: How to Account for Early Payment Discounts
1. Determine Eligibility: Assess if your business qualifies for early payment discounts.
This might seem like a no-brainer, but it’s important to reach out to your vendors to see if you can be included in their early payment program. They may have a certain dollar value threshold that you need to reach (or be under).
And if there is a contract between your company and the supplier, you’ll want to take a look at the fine print, and possibly have them add in those terms and conditions, especially if there are late payment or interest charges.
2. Evaluate Cost-Benefit Analysis: Analyze the potential savings versus the impact on cash flow.
Just because there are early payment discounts available, it doesn’t mean you have to use them. Some companies just don’t have the funds available to make those quick payments, or they need that cash for other business activities like payroll or tax installments.
It’s important to carefully assess your business’s financial health and forecast how it could affect your cash flow. Your accountant or bookkeeper can help you to analyze this.
3. Create Separate Accounts: Set up separate accounts to track early payment discount transactions.
Your chart of accounts will need at least one or two more accounts added if you want to take advantage and track early payment discounts. On the Accounts Receivable end, if you’re giving a discount to a customer, you’ll need to set up a the Sales Discounts account (in QuickBooks Online, this is Discounts/Refunds Given).
And on the Accounts Payable side, you’ll need a Purchase Discounts account set up, usually captured under Cost of Goods Sold.
4. Record Entries Correctly: Record invoice and bill entries to reflect the discounted amount and corresponding expense.
Utilizing your new accounts, you’ll want to code your invoices and bills accordingly. When your customer pays within the terms, you must now debit Sales Discounts (as it is a contra account). You can do this by adding the sales discount as a line item, or, if your QBO subscription allows it, you can enable a Discount box on your Sales Form Content, under Account and Settings.
The amount of the discount will determine how much you will be debiting your Sales Discounts account. Be cautious with your sales tax as you should still be collecting and remitting the full amount to the CRA.
When it comes to vendor bills, you will be crediting your Purchase Discounts account. You can add this as a new line item. Again, ensure the tax matches with your supplier’s bill, as the discount taken should not affect the amount of tax you are paying.
5. Monitor Accounts Receivable/Payable: Regularly review and update accounts payable to ensure accuracy.
Once you begin offering or taking early payment discounts, you’ll need to stay on top of your AR and AP reporting. You’ll have to determine if the customers taking discounts are in fact eligible per your terms, often by checking the days passed since the invoice was received (not the date of the invoice).
On the flip side, with vendor payments, make sure you are correctly entering the terms of each bill so that you know your eligibility as well. The bill payment screen in QuickBooks Online can be sorted by due date, so you know what’s coming up due first.
The Bottom Line: Maximizing Savings while Maintaining Accurate Financial Records
Taking advantage of early payment discounts can be a great tool for your business on both the accounts receivable and accounts payable side, to increase cash flow and maximize savings.
By offering discounts to customers, businesses can reduce their collections and increase the cash coming into their business. Accounts Receivable turnover is a key statistic to look at when considering offering discounts.
And by paying invoices promptly, businesses can take advantage of discounts offered by suppliers. This not only helps save money but also builds strong relationships with vendors.
When recording discounts on either AR or AP, it’s very important to keep accurate records of the discounts taken and ensure your sales taxes are unaffected.
So, while finding ways to maximize savings is important, it should always be considered against a company’s current financial status and cash flow situation. If you need help implementing any of these strategies, Simcoe Office Solutions can help! Contact us today for any of your bookkeeping needs.