Everyone is aware of “discounts.” Discounts are offered to encourage a garden pond operation’s customers to pay faster. A number of service-oriented businesses, like doctors and dentists, offer a trade discount of sorts for immediate payment upon completion of their services.
Suppliers often extend discounts in an effort to improve their cash flow. Few garden pond retailers, distributors, builders, manufacturers or breeders, however, have given much thought to either the cost of offering discounts or how much can really be saved by taking advantage of those discounts.
Prompt payments from customers mean improved cash flow for the garden pond operation, a reduced need for borrowed working capital and far fewer collection problems. Little wonder, then, that so many businesses offer discounts and incentives to speed payments. But, how much can you profit taking advantage of discounts offered by suppliers?
Discount, What Discount?
Many garden pond businesses closely follow the old adage: always delay cash outflows. For a surprising number of garden pond professionals, that means always paying bills on time but never before they are due. In reality, however, most pond businesses would be better off paying a bill early to take advantage of the trade discount. Consider the math.
The supplier’s invoice includes credit terms, listing the period of time for which credit is extended, the size of the discount offered if the buyer pays cash, and the date the credit period begins. A cash discount is a reduction in the purchase price provided the buyer pays within a specific time period.
A typical supplier’s credit terms may be stated as “2/10 net 30.” A buyer reads the terms as “a 2-percent discount will be allowed if the invoice is paid within 10 days. Otherwise, the balance is due in 30 days.” Why should anyone pay quickly in order to take advantage of a mere 2-percent discount?
Assume that a business has been extended credit terms of 2/10 net 30 on a $1,000 janitorial supplies purchase. By deciding to take the discount, the company will pay $980 ($1,000 less 2%).
By ignoring the discount, the full cost of $1,000 will be paid within the month.
The decision not to take the discount means the buyer is paying $20 to keep the money for an extra 20 days. Because there are slightly more than 18, 20-day periods in a year, the interest cost – on an annual basis – amounts to more than 36 percent. Obviously, this level of potential savings makes it a smart move to take the discount, even if money must be borrowed in order to do so. How then, can a garden pond business afford to offer customers a discount for prompt payment?
Discounts Cost as Well as Pay
It all boils down to the “cost” of those discounts. What does it cost a garden pond business to offer its customers a discount for cash or prompt payments? The answer can often be found in operation’s cash flow.
The principal disadvantage of offering discounts is the cost to the garden pond operation’s bottom-line profits arising from the loss of revenues. The cost of trade discounts must be weighed against the improved cash flow that can be expected. And, don’t overlook the impact on profits.
Obviously, the credit terms of your garden pond business should be designed to improve the operation’s cash flow. In its most basic form, cash flow is the movement of money in and out of the business.
In order to speed up the inflow of cash into their businesses, some retailers, distributors, manufacturers and contractors offer customers a trade discount off the original sales price if the customers pay within a specified period. The amount of the trade discount is typically one or two percent if the customers pay within 10 days. Full payment is normally due within 30 days if the customer doesn’t take advantage of the trade discount.
Pro and Con
Offering trade discounts has both advantages and disadvantages. For example:
ADVANTAGES: The main advantage to any garden pond professional who offers trade discounts is that it shortens the average collection period. Shortening that average collection period for accounts receivable is one of the biggest hurdles faced when attempting to accelerate the garden pond operation’s cash flow.
DISADVANTAGES: The primary disadvantage of offering trade discounts is the cost to the operation’s bottom-line profit that results from lost revenues.
Obviously, the cost of any trade discounts must be weighed against the improved cash flow expected. Another possible disadvantage is the increase in time necessary for billing and accounts receivable processing. In order to take full advantage of trade discounts, billing should take place as early as possible, which is generally the shipping date. For some small garden pond businesses, this may require additional clerical staff.
To Discount or Not to Discount?
Determining whether to offer or not to offer trade discounts requires the garden pond operation’s owner or manager to view the situation from two different perspectives: the bottom line perspective and the cash flow perspective. The option that strikes a balance between these two perspectives will help increase the garden pond operation’s cash flow – without sacrificing bottom line profits.
Consider the situation of SMITH’S BACKYARD WATER, a hypothetical business. Although the operation has been experiencing a steady build up in accounts receivable in recent months, slow collections have put a strain on the operation’s cash flow.
The operation’s owner is investigating the feasibility of changing the credit terms by offering a discount to its customers if their payments are received 10 days after shipment. The operation’s current credit terms call for full payment within 30 days of shipment.
If it is assumed that sales average about $25,000 per month; about 50 percent of the operation’s customers will take advantage of a one percent discount and an expected 75 percent will take advantage of a two percent discount and all customers not taking advantage of the discount are assumed to pay within 30 days. – See Chart.
Based on the figures of our hypothetical garden pond operation, offering no discount has the smallest impact on the bottom line, reducing the business’s profits by $2,750. Offering a two percent discount is the most costly, reducing the bottom line by $5,417.
From the cash flow perspective, a lower average investment in accounts receivable means a quicker inflow of cash. Offering the two percent discount significantly reduces the operation’s average investment in accounts receivable. This option would have the most favorable impact on cash flow problems.
Naturally, offering no discount is the most profitable but does nothing to increase cash flow. Offering a two percent discount would significantly increase the company’s cash flow but at the expense of its bottom line profit. Obviously, in this situation, a one percent discount reduces the operation’s bottom line by only $583, a small sacrifice for an increase in the operation’s cash flow. After all, this option increases cash flow by $8,334.
Profiting From Discounts
If a supplier offers payment terms extending beyond 30 days, it may be more advantageous to skip the trade discount and delay payment until the full amount is due. Generally, however, every garden pond professional should always take advantage of discounts of one percent or more when offered by suppliers requiring full payment within 30 days. Of course, in order to decide more precisely when to take a discount, the garden pond professional must compare that amount that would be earned by taking the discount to what it would cost to borrow money to make an early payment to a supplier.
Naturally, the amount of the discount and the time in which it is available can vary greatly. Usually, trade discounts are based on what is common for the supplier’s line of business. Some suppliers may offer a generous trade discount and some will offer none at all. Discounts, however, are usually negotiable.
One Step Further
Obviously, not every business owner or manager has enough clout with suppliers to negotiate better payment terms and discounts, but consider the potential rewards.
One business realized significant savings by negotiating standard payment terms from 30 to 45 days. Others have encouraged suppliers who didn’t normally offer discounts to give one in return for immediate payment – or by paying slower when they did not. In other words, the owners and managers of these businesses, in essence, created their own payment terms.
Why, then, are discounts so often overlooked or ignored by so many within the garden pond industry?