What is a Cash Discount?

Cash Discounts are the discounts or incentives the seller gives to the customer for paying dues on or before the due date as per the company’s terms and conditions.

  • The company offers it to its customers to make the early payment in cash. It is known as a sales discount from the perspective of the company selling the goods and a purchase discount from the buyer’s perspective.Cash discount reduces the chances of bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more that might arise due to non-payment of dues by the company’s customers. Thus with such a discount, the company generally gets more money when calculated for the overall business.In the case of a business unit where a sufficient amount of the cash reserves is available in the company, they only lead to fewer profits because the earlier recovery of cash is of no use and will not benefit the seller when checked on an overall basis.

Example of the Cash Discount

Let’s discuss an example of a cash discount.

Let’s take the example of A ltd, which deals with mobile phones and related accessories. It allows cash discounts and adopts the policy that if the buyer pays within ten days of the purchase date, the buyer will be given a discount of 1% of the invoice value. Now suppose a customer purchases a mobile phone worth $500 on 16th April 2019 on a credit basis and is given a 30 days credit period.

Now, if the customer discharges his dues till 25th April 2019, he has the liability to pay only $495 as 1% of $500, i.e., $5 is given as a discount for prepayment of dues. However, if the customer pays later than ten days, then no cash discount will be provided, and he is liable to pay the full amount of $500 to the company.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Cash Discount (wallstreetmojo.com)

Advantages of the Cash Discount

  • It is an incentive given by the company to its customers if they make the payment on or before the due date as per the company’s terms and conditions. To benefit from the discount, many customers pay right away to the company. So, it will save the company’s time, effort, and money, which it might have to spend on the collection process for collecting the due amount from the customers on time.When the customers pay on or before the due date, it results in faster access of cash flow to the companyCash Flow To The CompanyCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more, which the company can use for other necessary activities like paying bills on time, getting the benefit of discounts given by their supplier by paying them on time, etc.Due to cash discounts, many customers pay their dues on time. It reduces the company’s bad debts due to the non-payment of dues by the customers in the future. Thus with such a discount, the company generally gets more money when calculated for the overall business.

Disadvantages of the Cash Discount

  • The profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more is reduced unnecessarily due to the cash discount given by the seller. In the case of the business unit with satisfactory cash reserves, it only leads to fewer profits because the earlier recovery of cash is of no use and will not benefit the seller. Still, if the cash discount is not given, then obviously, the business’s earnings can be increased.The policy of cash discounts will lead to time-consuming bookkeeping basicsBookkeeping BasicsBookkeeping is the day-to-day documentation of a company’s financial transactions. These transactions include purchases, sales, receipts, and payments.read more of accounts for the organizations as they are required to create cash discount allowances for which well-skilled staff is needed to be employed, and it involves a lot of time and estimations.Sometimes the cash discount policy may lead to the loss of customers as many people think that a small delay in discharging dues may result in the loss of the discount. Now there is a possibility that they may get opposed to not being given a discount, and they may prefer to walk out without making any purchase.It will lead to a reduction in the sales value or turnover of the business. Turnover is the main criterion that the investor evaluates before investing in the business. There are chances that less turnover may stop an investor from investing their funds in that business.

Conclusion

From the point of view of the company, cash discounts save time, effort, and the money for the company, which it might have to spend on the collection process for collecting the due amount from the customers on time and the point of view of the customers it will save the money of the customer as he will get the discount for early payment. However, although the cash discounts given to the customers can improve the cash flow of the business along with reducing its bad debts, at the same time, it might lead to a reduction in the profit margin of the seller unnecessarily.

This has been a guide to what a cash discount is, and its meaning. Here we discuss the practical example of a cash discount with advantages and disadvantages. You can learn more from the following articles –

  • Trade Discount vs Cash DiscountTrade Discount DefinitionAccounting for Sales DiscountsDiscounting Formula