What is Cash Discount?
Cash Discounts is defined as the discount or the incentive given by the seller to the customer for paying the dues on or before the due date of the payment as per the terms and conditions of the company
- It is offered by the company to its customers for making the early payment in cash and is known as 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 debts 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 the business unit where there is a sufficient amount of the cash reserves 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. He allows cash discount and adopts the policy that if the buyer pays within 10 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 10 days then no cash discount will be given 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 of the payment as per the terms and conditions of the company. In order 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 the amount on or before the due date then leads to the faster access of the cash flow to the company which can be used for the other necessary activities of the company like paying the companies bill on time, getting the benefit of discounts given by their supplier by paying them on time etc.
- With the help of the cash discounts, many of the customers pay on time against their dues to the company. This reduces the chances of the bad debts that might arise in the future due to the non-payment of dues by the customers of the company. Thus with such discount, the company generally gets more amount of money when calculated for the overall business.
Disadvantages of the Cash Discount
- The profit margin 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 of accounts as the organizations as they are required create cash discount allowances for which well-skilled staff is required to be employed and it requires 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 doing 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.
Conclusion
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.
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