Early settlement discounts: The pros and cons

05/09/2022

When looking for ways to improve credit control performance, a tactic which, on the surface, reduces profit margins might not be high on your list of priorities. But dig a little deeper and you’ll find there’s a whole host of reasons some businesses find early settlement discounts incredibly valuable.

Early settlement discounts essentially give your customers a financial incentive to pay your invoices earlier than they otherwise would. If you invoice on 30 day terms, for instance, you might offer a 2.5% discount to customers who pay within the first seven.

Whilst it’s true that’s 2.5% you’re effectively giving up, the value to your business of receiving payment so quickly could outweigh it – for a number of reasons.

There’s no hard and fast rule about how much to discount invoices by, whether it should apply to every invoice or how long you should give customers to take advantage. The key thing is to assess what’s suitable for your business.

To help you assess the merits of such a tactic, here are a few of the pros and cons of early settlement discounts.

Pros

Improves cash flow

Perhaps the number one benefit of early settlement discounts is that receiving payment early from customers assists with cash flow.

Credit terms are one of the key cash flow killers, especially when businesses give customers 60 or 90 days (or more) to pay after supplying the goods or services.

By reducing this gap, you’ll have access to additional funds which can be used to fulfil other orders, invest in growth – or simply meet your day-to-day commitments.

Early settlement discounts are therefore a useful tool if cash flow is a significant concern or consideration for your business.

Lowers risk of late payment

With late payment such an issue currently, anything you can do to reduce this risk ought to be considered.

Typically, businesses will wait as long as possible to pay invoices which are owed. And while your customer may have every intention of paying within the agreed credit terms, something could happen during that period which affects their finances to the extent they need to delay payment.

This risk is removed for any customer who takes advantage of the early settlement discount, and it also frees up credit control resource as that’s one less customer you need to keep on top of.

Encouragement for notoriously poor payers

Remember that early settlement discounts don’t need to be applied to every customer.

Instead, the tactic could be best employed for customers which have a track record of paying your invoices late.

Such an incentive could be all that’s required to encourage them to pay your invoices within terms – not to mention reduce the headaches faced by your credit control staff when chasing the same valued customers for overdue payments on a recurring basis!

Reduces requirement for external funding

A common reason businesses require external finance is to assist with cash flow, whether that’s to combat the impact of offering credit terms to customers or otherwise.

By incentivising customers to pay early and improving your cash flow as a result, it reduces the requirement for external funding.

In such instances, the amount you discount your invoices by can therefore be offset against the cost of borrowing, often making it more cost effective to offer early settlement discounts than securing external finance.

Increases customer loyalty

We all love a saving, don’t we? So if you’re looking for something to encourage your customers to keep coming back to your business over a competitor, early settlement discounts could be a useful incentive.

It may not be a huge saving for them, but every little helps, and it could even encourage customers to increase the size or frequency of their orders with you.

It doesn’t have to be a discount

Not all customers will be influenced by the prospect of a small saving, of course. It could be that your business instead makes a donation to charity each time a customer pays early, for example.

If you like the idea of early settlement discounts but can’t afford to reduce your margins, you could enter customers who pay within a certain timeframe into a competition or prize draw. The competition could even be designed to encourage future purchases from you.

Get creative and consider what might appeal to your customers, knowing what you do about them.

Cons

Reduces margins

The obvious drawback to early settlement discounts, as we have already touched upon, is that the discount eats into your profit margins.

Not every business can afford to give up a portion of their sales for such an incentive, and discounts aren’t necessary if your customers typically pay on time and cash flow isn’t an issue.

The key thing is to weigh up the financial impact of introducing such discounts against the overall value you would gain from them.

Additional admin

Overseeing, promoting and administering such discounts is definitely a consideration.

Ensure that the right processes are in place so that your credit control staff know which offers exist, when they expire for each customer, and that they are accounted for.

Early settlement discounts can also make cash flow forecasting a bit more challenging given you won’t know (initially) what proportion of your customers will take up the offer. However, after a bit of time, you should have a clear enough picture to forecast accurately.

Other alternatives

Another drawback with early settlement discounts is that not every customer will take advantage. So if you’re introducing them as a means to improve cash flow, lower late payment and reduce the burden on your credit control staff, there’s a chance it may not have much impact.

Instead, it could be worth considering a funding tool such as invoice finance, which enables businesses to access up to 90% of their invoice value within 24 hours of being raised. The remainder is forwarded once the customer pays, minus a small fee for the lender’s services.

Funding can be advanced against every invoice you raise or just a select few, depending on your requirements, while lenders can also provide a dedicated sales ledger management service to remove this burden from your business.

To find out more about invoice finance, click here.

Do you offer early settlement discounts? We’d love to hear what impact it has had on your business. Please share your experiences in the comments below.