Is it worth it to incentivize customers with early payment discounts?

Is it worth it to incentivize customers with early payment discounts?

Wouldn’t it be nice if every customer paid in full on the day of purchase? In a perfect world, that is the gold standard that every business owner would expect. However, this is reality and late payments are an unavoidable part of business. Are early payment discounts a viable solution to this age-old problem?

What is an early payment discount?

As the name suggests, early payment incentives are discounts that are offered to customers who pay for products or services in advance of the terms that they and the creditor have agreed upon. There are three types of early payment discounts:

  • Static discount. This addition to your credit terms typically comes in this form: 2/10, Net 30. In other words, “If you pay me in less than 10 days, I will give you a 2 percent discount. Otherwise, you will owe me the full balance in 30 days.” Although this setup does give your customers an enticement to pay you in advance, it also requires extra work on the part of your accounting staff to keep track of timing and amounts paid.
  • Sliding scale discount. In this modified static discount, the amount is adjusted according to the payment date. Under this arrangement, the customer tells you what APR amount they are willing to accept in order to pay you early. You can determine when you get paid and set the time window, adjusting the rate according to how many days in advance that you are given the money you are owed.
  • Dynamic discounts. This payment arrangement allows several of your customers to pool their purchasing power to raise needed cash and set a targeted rate of return. In this instance, you as the business owner are able to have more control over the discount rate and are not locked into a static discount rate.

Whichever type of early payment discount you offer, one fact remains the same: What you might lose by offering your customer a small reduction in what they owe will be dwarfed by the benefits that your business will receive by having most of your cash where it belongs: In your pocket, contributing to your cash flow.

Advantages of early payment discounts.

Having those dollars back in your cash register instead of in your customer’s possession is one of the most obvious reasons to consider making early payment discounts a part of your business practices. However, there are other upsides as well. These include the following:

  • Ready access to your own cash. This can be used for daily expenses, to pay bills, or to put into savings for a rainy day.
  • The ability to have better control over important metrics such as days sales outstanding (DSO).
  • Having access to funds during difficult times or at quarter’s end.
  • Enhanced ability to manage your working capital.

Who doesn’t like to feel special or that they have been given a good deal? When your customers realize that you are willing to go the extra mile and dig into your own funds to give them a payment incentive, they not only will be more receptive to paying early but will also actually feel good about doing so. Best of all, they will be left with a positive feeling about you and your business. Considering that it is always easier to keep an existing customer than it is to woo a new one, this amounts to a win-win for both of you.

In most cases, these benefits tend to outweigh business owners’ concerns about tight margins, especially considering that other ways of gaining fast capital such as nontraditional loans can become very pricey in the long term.

Is it the right time to offer early payment discounts to your customers?

All customer loyalty programs come at a cost and that includes early payment discounts. However, as we have seen above, these discounts can often pay for themselves many times over. In order to determine if this is a good time to grant this incentive, ask yourself the following questions:

  • Would offering a discount cost less than what you are currently paying to borrow the cash you need?
  • Are you currently factoring your invoices to obtain funds? If so, can you get out of your loan agreement?
  • Does one of your goals involve performing better on financial metrics such as DSO?

If you answered “yes” to one or more of these questions, now might be the time to incorporate early payment discounts into your current business model.

A word about communication.

Even the most carefully conceived plans can fall apart when channels of communication fail. For example, there inevitably will be customers who take the discount but still do not pay on time. Although you will never be able to guarantee that this does not happen, you can drastically minimize the likelihood by writing your early payment discount terms clearly and ensuring that customers receive them in hard copy and, ideally, via email as well.

In these precarious times when businesses are operating on the thinnest of profit margins, early payment discounts can prove to be lifesavers. The vendors and customers who owe you money will also benefit from receiving reductions in what they owe, resulting in solid advantages for all parties. In short, early payment discounts are a terrific way to reward clients while simultaneously giving you faster access to the funds you need to keep your business moving forward.