Continuing on the subject of winning strategies for business success, prompt payment discounts in theory may appear to be a good debtor management tool. You offer your customers a discount in return for their prompt payment of your invoices.
Let us look at this in more depth namely what the risks, costs and benefits are: For example you offer a 2.5% discount for payment within seven to ten days of the invoice date and as a result of this your customers pay two months earlier. This is actually the equivalent to paying interest at 15% per annum on the value of all the invoices you issue with the incentive, and may appear to be and probably is a reasonable cost compared to the alternative of having a correspondingly large financing facility.
However if as a result of your 2.5% prompt payment discount your customer only pays one month earlier, the interest cost per annum doubles to 30%. Now you will see that this is becoming very expensive. What is even worse, and this will be particularly noticeable with your larger customers, your invoice will be paid after one month but the discount will still be deducted, making the real cost of your incentive even higher.
Faced with the situation of confronting the debtor and demanding the correct payment too many managers, afraid at risking upsetting these important customers, will just accept the short paid invoice. You have actually become banker by default to these customers and you are providing them with free credit. The larger the value of the invoice, the greater the real corresponding cost to your business will be.
I think you will agree, if you are allowing this practice in your business, it is very far removed from effective debtor management. For more valuable information on small to medium business management and strategy.