Early Payment Discount

An early payment discount, or cash discount, rewards customers for paying ahead of terms: 2/10 net 30 means the buyer may deduct 2 percent by paying within 10 days, otherwise the full amount is due in 30. Sellers use discounts to accelerate cash conversion, reduce credit exposure duration, and, in some industries, simply to match entrenched convention. Buyers with cheap capital treat the discount as a high-yield investment and take it systematically.

The seller's cost is steep when annualized. Giving up 2 percent to receive funds 20 days sooner is equivalent to borrowing at roughly 36 percent per year; the discount only makes economic sense when the seller's cost of capital is very high, liquidity is strained, or the risk reduction on marginal accounts is worth paying for. The formula for the annualized cost is the discount percent divided by (100 minus the discount percent), times 365 divided by the days accelerated.

The operational plague is the unearned discount: customers who pay on day 25 and take the 2 percent anyway. Each instance is small; systematically tolerated, it becomes an unpriced 2 percent rebate to your worst-behaved payers and a deduction-management workload. Policy should define the grace tolerance (if any), chargeback of unearned discounts above a threshold, and escalation for repeat offenders, and cash application needs to detect the short pay at posting time rather than months later in account reconciliation.