Early Payment Discounts and Dynamic Discounting

30.10.2019

Topic: Dynamic Discounting | AP Automation

Discounts have long been part of the practice of business negotiations, typically offered by vendors to customers. Discounts might be offered when a large volume has been purchased or when a deal is closed shortly before a certain cutoff date such as the end of the quarter. However, a new trend is to be observed – customers, too, are suggesting discounts: for early payment.

Rather than aiming to close a deal more quickly or sell more volume, the purpose behind a discount such as this is merely to offer incentive for earlier payment. It is attractive to the vendor primarily for reasons related to cash flow and liquidity. If the discount is higher than the interest that would have been earned with the cash, then a deal such as this might also be attractive to the customer. With interest rates at a low worldwide, early payment discounts are a win-win deal, both for customers and for vendors.

German-speaking countries and Skonto

It is only in the international sphere that the concept of early payment discounts has gained in relevance in recent times. In German-speaking countries, it has been common practice for decades. There is even a phrase for it: Skonto. The line "Payment in 14 days, 2% Skonto, 30 days net" or something much of this sort is read by accountants in German-speaking countries dozens of times a day.

This is how to interpret this line: the payment term for the invoice is set at 30 days. However, if the customer pays the invoice within 14 days, a discount of 2% will be granted. If payment is made between day 15 and day 30, the customer will no longer be entitled to an early payment discount.

These early payment discounts are generally defined in the terms and conditions for delivery. This means that the same conditions apply to all of a vendor’s invoices. Furthermore, there is usually only one rate for the discount. Regardless of whether the customer pays exactly at the deadline for the discount or pays a few days in advance, he will receive the same percentage.

Dynamic discounting – the next level up?

Dynamic discounting works with the same idea as early payment discounts: If you pay early, you pay less. In contrast to early payment discounts like Skonto, however, it is more flexible; or, as the name suggests, it is simply more dynamic.

The same discount does not apply automatically to all invoices of a vendor. A new discount is decided on for each individual invoice, and each discount is set for a specific time frame. With dynamic discounting, though, there may be any number of intermediate stages with different payment terms and discount levels.

And finally, the idea of dynamic discounting is bidirectional. For each invoice, the customer can suggest receiving a discount for faster payment — just as the supplier can offer a discount of his own accord. Dynamic discounting takes up the idea of early payment discounts and enhances it with a plus in flexibility.

What are the requirements for dynamic discounting?

The particularities of dynamic discounting as compared to classic early payment discounts bring out one disadvantage in particular: Management is significantly more complex for both suppliers and customers, a result of the dynamics and individual preferences involved. Dynamic discounting can hardly be realized manually or without automation. A vendor or business partner portal may thus be the necessary solution.

There is another decisive point when it comes to being able to use dynamic discounting or early payment discounts: As a customer, you must be able to pay invoices by the payment date – and even earlier – in the first place. This brings us to the processing times of invoices.

Reduced invoice processing cycles provide scope for action

For many companies, reducing the time in which an invoice is paid is a challenge in itself, simply because the processing is too time-consuming (the processing time being the timespan from the receipt of an invoice to its posting in the ERP or accounting system). Not only are work steps such as "checking," "coding" and "approving" both time-consuming and costly; merely getting data into the ERP system tends to be a drawn-out process, one which always involves idle times. Without automation, these steps alone often take over two weeks for many companies.

This means that the timeframe for taking advantage of discounts has often already elapsed and the scope for dynamic discounting may also be limited. Ultimately, if a company wants to take advantage of early payment discounts, a good first step is always to optimize and automate the processes involving invoice receipt and payment. By introducing a workflow solution, the processing time for invoices can, on average, be cut in half, providing the leeway needed to use early payment discounts or dynamic discounting.

In the results of our 2018 customer survey, you can find out more about the processing times of invoices and what numbers are realistic in practice. To read it, please download it as a PDF here.