The real cost of using customer discounts to finance your business

According to the Q3 2021 Prompt Payments Report by ISME (Irish SME Association), the average time to payment in Ireland is 46 days. That’s around 50% more than the typical credit term of 30 days, so it’s no surprise that offering early payment or upfront payment discounts looks like an attractive course of action. The rate offered ranges anywhere between 1-3%.

That’s quite a wide range and it does vary by industry type and more importantly, how early the payment will be. For example, a supplier may offer two discount tiers based on different payment schedules. The first tier may operate on the basis of ‘2% 10 Net 30’, meaning the buyer can deduct 2% from the invoice price if they pay within 10 days of the invoice date. The second tier may be something like ‘1% 20 Net 30’, meaning the buyer can deduct 1% from the invoice price if they pay within 20 days.

But how attractive is it in real terms?

Let’s look at a simple example. As we are looking at trying to establish the cost of getting paid upfront, we will use the average of the discount rate range, 2%.

Example

Company A has landed a contract worth €1.2M. The agreement is to bill in 12 monthly installments and the credit payment term is 45 days. The customer is offering a 2% discount on each payment of €100,000, with a guarantee that the invoice will be paid on presentation.  In reality, the real cost of funds the customer is offering Company A is:2%*360/45 days = 16% Annual Equivalent Rate

The margin impact on this discount is €20,000

The discount rate for early payment range of 1-3% means the cost using those payment terms is the equivalent of anywhere up to 24% cost of funds.Putting it into these terms, it can be an extremely expensive financing option and longer term, could have a major impact on the business beyond merely squeezing margins.

The often unseen costs of customer payment discounts

For many businesses, repeat business with customers makes up a majority of their revenue. Offering discounts could be seen as a cost to keeping a healthy relationship with their customer. However, there are a number of often-unseen costs to a business accepting customer discounts.

High cost of finance

As discussed above accepting a discount for advance payment can work out quite expensive for the business to accept, thus affecting directly on gross margins and ultimately squeezing the bottom line.

Poor future negotiation positioning

Probably the most important thing to consider when accepting a discount from a customer is how this will affect the relationship going forward. By accepting a discount for early payment, you are sending a signal to your customer that 1) you need cashflow immediately which could be seen as a weakness, and 2) the customer may continue to look for discounts at each opportunity going forward, perhaps even increasing as they are aware you need cash now.  If it’s a large customer that you see a real opportunity to grow with, this could really impact the company going forward.

The only way is down

As we have seen recently, macro inflationary trends and rising costs has seen a lot of businesses having to increase their prices just to stay still. If you have embarked on a relationship that is based on discounting, how likely is it that you will ever be able to increase prices?

Business reputation

If you offer one customer in the industry discounts, you might get other customers looking for discounts as well. If a number of your customer relationships are based on discounts, then the profitability of the business in total is undermined. In every sector, there are companies that have a reputation for doing discounts – It’s not a reputation you want amongst your customers.

So, what’s the alternative?

There are better, more cost-effective ways of receiving up-front payments to boost cashflows, allowing your business to increase growth multiples. One way is to utilize Invoice Finance with single or multiple invoices on a B2B funding platform like InvoiceFair.For the purposes of this example, we will focus on Selective Invoice Finance. So, back to Company A and their recent new contract win worth €1.2m to be billed in 12 equal monthly invoices. Instead of offering their debtor a discount for early payment of 2% per month, they could trade the invoice and pay a cost of funds of 1% per month or 12% annualized. They will receive 90% of the value of the invoice (less finance costs) within 24 hours of approval and the remaining 10% when their debtor pays the invoices on normal terms. 

That gives them upfront cash at a lower cost without compromising the customer relationship. It also means that Company A now has a reliable, flexible funding partner with an ‘always-on’ source of funds as they grow into the future. They can decide to trade any invoice from any number of their customer whenever they need to. They are not caught in a long-term binding agreement that is tricky to get out of or a pricing structure that limits the profitability of the business and has a negative impact on cash flow.

There are of course other forms of trade finance like business loans, leasing or asset finance, equity finance, but these all either involve a longer-term commitment, restrictive costing, or do not have the flexibility of invoice finance.

About InvoiceFair

InvoiceFair is a funding platform where companies can convert past or future revenues into cash quickly. It does this by advancing funds against invoices, claims, or a company’s predictable future revenues which can then be used as upfront growth capital. Uniquely, we provide funding at every stage of the credit lifecycle, offering a powerful mix of solutions to help companies grow. This allows them to take control, react to market opportunities, grow faster and create more value without restriction. In the past 5 years, we have advanced an impressive €1bn+ to growing UK & Irish companies.

Solutions available include:

Selective Invoice Finance: Choose the individual invoices you want to finance

Innovative Invoice Discounting: Finance your entire Debtor Book plus a portion of your WIP

Revenue Based Finance: Raise cash against your future revenues and subscriptions today.

Claims Finance: Raise finance against work completed but not yet invoiced to your blue chip debtors.

Call our Business Development team on 003531 6632662 or email busdev@invoicefair.com for a bespoke consultation on how InvoiceFair could give your business the freedom to fund your own future.