What is a Cash Discount?
Cash Discounts are the discounts or incentives given by the seller to the customer for paying dues on or before the due date as per the company’s terms and conditions.
- The company offers it to its customers to make the early payment in cash. It is known as a sales discount from the perspective of the company selling the goods and purchase discount from the perspective of the buyer purchasing the goods.
- Cash discount reduces the chances of the bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation. that might arise in the future due to non-payment of dues by the customers of the company. Thus with such a discount, the company generally gets more amount of money when calculated for the overall business.
- In the case of a business unit where a sufficient amount of the cash reserves is available in the company, they only lead to fewer profits because the earlier recovery of cash is of no use and will not give any benefit to the seller when checked on an overall basis.
Example of the Cash Discount
Let’s discuss an example of a cash discount.
Let’s take the example of a company named A ltd, which deals with mobile phones and related accessories. It allows cash discount and adopts the policy that if the buyer pays within ten days of the purchase date, the buyer will be given a discount @ 1% of the invoice value. Now suppose a customer purchases a mobile phone worth $500 on 16th April 2019 on a credit basis and is given 30 days credit period.
Now, if the customer discharges his dues till 25th April 2019, he has the liability to pay only $495 as 1% of $500, i.e., $5 is given as a discount for pre-payment of dues. If the customer pays later than ten days, then no cash discount will be provided and is liable to pay the full amount of $500 to the company.
Advantages of the Cash Discount
- It is an incentive given by the company to its customers in case they make the payment on or before the due date as per the company’s terms and conditions. To get the benefit of the discount, many customers pay right away to the company. So, it will save the time, efforts, and money of the company, which it might have to spend on the collection process for collecting the due amount from the customers on time.
- When the customers pay on or before the due date, it results in faster access of cash flow to the companyCash Flow To The CompanyCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. , which the company can use for other necessary activities like paying bills on time, getting the benefit of discounts given by their supplier by paying them on time, etc.
- Due to cash discounts, many customers pay their dues on time. It reduces the company’s bad debts that in the future due to the non-payment of dues by the customers. Thus with such a discount, the company generally gets more amount of money when calculated for the overall business.
Disadvantages of the Cash Discount
- The profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. is reduced unnecessarily due to the cash discount given by the seller. In case of the business unit where there are satisfactory cash reserves, it only leads to fewer profits because the earlier recovery of cash is of no use and will not give any benefit to the seller but if the cash discount is not given then obviously the earnings of the business can be increased.
- The policy of cash discounts will lead to time-consuming bookkeeping basicsBookkeeping BasicsBookkeeping is the day to day recording of financial transactions such as purchases, sales, receipts, and payments, and it is the first step in the accounting process. It can be prepared in two ways: single-entry and double-entry; however, the double-entry approach is more widely used and recognized in most countries. of accounts for the organizations as they are required to create cash discount allowances for which well-skilled staff is needed to be employed, and it involves a lot of time and estimations.
- Sometimes the cash discount policy may lead to the loss of customers as many people can think that a small delay in discharging dues may result in the loss of discount to them. Now there is a possibility that they may get opposed that they are not given a discount, and they may prefer to walk out without making any purchase.
- It will lead to a reduction in the sales value or turnover of the business. Turnover is the main criterion that is evaluated by the investor before investing in the business, and there are chances that less amount of turnover may stop an investor from investing their funds in that business.
From the point of view of the company, cash discounts save time, efforts and the money of the company which it might have to spend on the collection process for collecting the due amount from the customers on time and from the point of view of the customers it will save the money of the customer as he will get the discount for early payment. Although the cash discounts given to the customers can improve the cash flow of the business along with reducing its bad debts, at the same time, it might lead to a reduction in the profit margin of the seller unnecessarily.
This has been a guide to what is cash discount and its meaning. Here we discuss the practical example of a cash discount with advantages and disadvantages. You can learn more from the following articles –