What does 2/10 net 30 mean?
It means the supplier takes 2% off the invoice if you pay within 10 days of the invoice date, and otherwise expects the full amount within 30 days, the very example NOAA’s guidance on cost effective discounts works through. Skipping the discount is, in effect, borrowing from your supplier for 20 days, and the same NOAA guidance puts the annual cost of that borrowing at about 36%. For an owner with cash available to pay early, that is a return few other safe uses of spare cash can match, so it is worth knowing which suppliers offer it and making sure the team actually takes it.
What is an early payment discount?
It is a price reduction a supplier offers in return for being paid sooner than the invoice requires, written on the invoice as its payment terms. IRS Publication 334 calls it a cash discount, an amount the seller permits you to deduct from the invoice price for prompt payment. The first number is the discount, the second is the number of days you have to take it, and the number after “net” is when the full amount becomes due.
How do you work out the annualized return of an early payment discount?
Divide the discount by the amount you actually pay, then scale that result from the days you pay early up to a full year. The days you pay early are the net days minus the discount days, so on 2/10 net 30 you pay 20 days sooner than necessary, and 365 divided by those 20 days tells you how many such periods fit into a year. The product is the yearly rate the discount earns on the cash you surrender early, which you can compare directly with the rate you pay to borrow or the interest your spare cash earns at the bank. Federal guidance such as NOAA’s counts a 360-day year instead, which produces a slightly lower figure.
Worked example: a Cascade Pipe & Supply invoice at Ferrygate
Ferrygate Plumbing & Heating is an invented company, one of the Demo companies Ressura uses to demonstrate its checks, and every figure here is invented for illustration. Its pipe supplier, Cascade Pipe & Supply, sends an invoice for $18,400 on 2/10 net 30 terms.
- Invoice dateCascade sends the $18,400 invoice on 2/10 net 30 terms.
- Day 10The last day to pay $18,032 and keep the $368 discount.
- Day 30The full $18,400 is due.
The discount is 2% of $18,400, which is $368, so Ferrygate can pay $18,032 on day 10 or $18,400 on day 30. Paying early means surrendering $18,032 twenty days sooner in exchange for $368, a return of 2.04% for 20 days. A year contains 18.25 periods of 20 days, so the annualized return is 2.04% multiplied by 18.25, approximately 37.2%, and if the discount could be reinvested every period, the compounded rate would approach 44.6%.
Suppose Ferrygate has no spare cash and would draw on a line of credit at 9% a year to pay early. Borrowing $18,032 for 20 days at 9% costs about $88.93 in interest, so taking the discount still leaves Ferrygate $279.07 better off, and buying from Cascade on these terms every month makes the discounts worth $4,416 a year.
The same arithmetic ranks the other suppliers: 1/10 net 30 is worth about 18.4% a year, and 2/10 net 60 only about 14.9%, because the identical discount is spread over 50 days.
When is an early payment discount not worth taking?
When the cash costs you more than the discount earns, or when paying early would leave you short. The federal government applies this test to its own bills: the Treasury’s prompt payment discount calculator tells agencies to accept a discount when its effective annual rate exceeds the Treasury’s current value of funds rate, and otherwise to pay as close to the due date as possible. A business can apply the same rule using its own borrowing rate, but if paying early would mean missing payroll or a tax deposit, conserve the cash.
A discount is also worth having only on an invoice that is correct, because ten days is less time to check the price, the quantity and the fees, and a discount never makes up for a price above the one you agreed. Taking it squeezes two steps of the procure-to-pay process, matching and approval, into ten days.
How do you record a discount you take?
IRS Publication 334 describes two methods: deduct the discount from your purchases, or credit it to a separate discount income account. Publication 334 says you must use the chosen method every year for all your purchase discounts, so agree on one with your accountant and apply it consistently.
How can you check an invoice before you pay it early?
Ressura’s Procure-to-Pay Module checks each supplier invoice against your agreement as it arrives, so paying within ten days does not mean paying a price nobody agreed to. It compares every unit price with the agreement on the invoice date, matches each fee to one the agreement allows, adds the invoice up again and flags an invoice sent twice, showing any gap in dollars. For what to compare by hand, see how to check supplier invoices against agreed prices.